What Is Utility?

What Is Utility?

Utility is the total satisfaction or benefit you get from consuming a good or service. I see economic theories based on rational choice assuming that you'll strive to maximize your utility. The utility of a good or service directly influences its demand and price. Economic models try to quantify or estimate utility to figure out your decision-making.

Utility Theory

The utility definition in economics relates to the concept of usefulness. An economic good yields utility to the extent it's useful for satisfying your want or need. Various schools of thought differ on how to model economic utility and measure the usefulness of a good or service.

Early economists from the Spanish Scholastic tradition in the 1300s and 1400s described the economic value of goods as deriving directly from this property of usefulness, basing their theories on prices and monetary exchanges.

Utility in economics was first coined by the 18th-century Swiss mathematician Daniel Bernoulli. To Bernoulli and other economists, utility was modeled as a quantifiable or cardinal property of the economic goods you consume.

Measuring Utility

Economic utility can be estimated by observing your choice between similar products. However, measuring utility becomes challenging as more variables or differences are present between the choices.

Ordinal Utility

Economists of the Austrian School developed the ordinal theory of utility, the idea that you order or rank the usefulness of various units of economic goods. Carl Menger used this framework to resolve the diamond-water paradox: the first available units of any economic good will be put to the most highly valued uses, and subsequent units go to lower-valued uses. The ordinal theory of utility explains the law of diminishing marginal utility and the fundamental laws of supply and demand. In ordinal utility terms, if you have three slices of pizza, you might eat the first, share the second with a friend, and waste the third.

Cardinal Utility

This assumes a util represents the amount of satisfaction a specific good or service generates for a subset of people in various situations. The concept of a measurable util makes it possible to treat economic theory and relationships using mathematical symbols and calculations. However, utils cannot be observed, measured, or compared between different economic goods or between individuals. For example, if economists determine that a piece of pizza yields 10 utils and a bowl of pasta yields 12 utils, you'll know that eating the pasta will be more satisfying. Producers of pizza and pasta will then price pasta higher than pizza.

Total Utility

If utility in economics is cardinal and measurable, the total utility (TU) is the sum of the satisfaction you receive from the consumption of all units of a specific product or service. Using the example above, if you can only consume three slices of pizza and the first slice yields ten utils, the second slice yields eight utils, and the third slice yields two utils, the total utility of pizza would be twenty utils.

Marginal Utility

This is defined as the additional (cardinal) utility you gain from the consumption of one additional unit of a good or service or the additional (ordinal) use you have for an additional unit. Using the same example, if the economic utility of the first slice of pizza is ten utils and the utility of the second slice is eight utils, the marginal utility (MU) of eating the second slice is eight utils. If the utility of a third slice is two utils, the MU of eating that third slice is two utils.

Why Is It Difficult to Accurately Measure Utility?

There is no direct way to measure the utility of a certain good for each consumer, but economists may estimate utility through indirect observation. For example, if you're willing to spend $1 for a bottle of water but not $1.50, economists may surmise that a bottle of water has economic utility somewhere between $1 and $1.50. However, this becomes difficult in practice because of the number of variables in your typical choices.

What Assumptions Do Economists Make About Consumer Decision-Making?

Economists assume that you seek to maximize your utility and are motivated by a specific need, such as happiness, wealth, or generosity.

How Is Consumer Spending Affected by Utility?

Suppose utils are used to measure consumer demand. A first slice of pizza may yield 10 utils, but as more pizza is consumed, the utils may decrease as you become full. This process reveals that you may maximize your utility by allocating your money between multiple types of goods and services.

The Bottom Line

Utility can be used to measure the usefulness of goods and services to you as a consumer. While there are limitations when more variables and differences appear in the market, various types of economic utility are identified. Measuring utility helps companies structure pricing based on the laws of demand. Utility is a term also used to describe the services you receive from energy companies, such as electricity.