Principles of Economics/Utility

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Definition of Utility[edit]

Utility is a term used by economists to describe the measurement of "useful-ness" that a consumer obtains from any good. Utility may measure how much one enjoys a movie, or the sense of security one gets from buying a deadbolt. The utility of any object or circumstance can be considered. Some examples include the utility from eating an apple, from living in a certain house, from voting for a specific candidate, from having a given wireless phone plan. In fact, every decision that an individual makes in their daily life can be viewed as a comparison between the utility gained from pursuing one option or another.

Example: Sally wakes up in the morning, and her mother offers her the choice of a grapefruit or cereal. Sally, in an instant, compares the utility she would derive from both choices and selects the cereal. Sally's mother then needs to take Sally to school. She can either walk or drive. Sally's mother considers the benefits of exercise and fresh air, which compose the utility she would derive from walking, and also considers the time savings and comfort of driving. Sally's mother decides to drive.

In this example, it can be seen that utility is measured in numbers that are purely cardinal, rather than ordinal. The numbers used to measure utility (often in a unit called the "util") is useful only for comparison. If the utility given by one thing is 100 and the utility given by another is 12,000, we can only say that the utility of the latter is greater. We could not say that the individual gets "120 times more utility" from this option, because utility is not a quantity. Furthermore, the sign of utility may be positive or negative with no effect on its interpretation. If one option gives -15 utility and another gives -12, selecting the second is not, as it might seem, the "lesser of two evils", but can only be interpreted as the better option.

Also illustrated in the example above is that what may seem better for a person is not reflected in their utility. That is, Sally gains more utility from eating the cereal, but maybe the cereal is very unhealthy compared to the grapefruit. This consideration will be accounted for in Sally's utility according to how much she cares about it. If Sally does care about, in this case, the nutritional value of her food, this would mean that the grapefruit would provide greater utility than if she does not care about nutrition at all. The same is true for her mother's decision about driving to school. If she is environmentally conscious, driving would have given less utility than if she is not. These factors may, though not necessarily, affect the outcome of the decision. This point leads to the statement that, when measuring utility, we assume that all things have been taken into account. The amount of utility that Sally gets from her cereal takes into account all factors relevant to that decision.

Utility can be seen as a measure of how much one values a particular good. This depends entirely on the preferences of that individual, rather than some external, or universal measure. So while an apple and an orange may give utility values of 5 and 10 respectively to one individual, they may give 1,250 and -180 to another. These values depend only on how they are valued by the decision makers in each case.

Rationality and Utility[edit]

In economics, we usually say that an individual is "rational" if that individual maximizes utility in their decisions. That is, whenever an individual is to choose between a group of options, they are rational if they choose the option that, all else equal, gives the greatest utility. Recalling that utility includes every element of a decision, this assumption is not particularly difficult to accept. If, when everything is taken into account, one decision provides the greatest utility, which is equivalent to meaning that it is the most preferred, then we would expect the individual to take that most preferred option.

This should not necessarily be taken to mean that individuals who fail to quantify and measure every decision they make are behaving irrationally. Rather, this means that a rational individual is one who always selects that option that they prefer the most.

The rationality assumption may seem trivial, but it is basic to the study of economics. This assumption gives a basis for modeling human behavior and decision making. If we could not assume rationality, it would be impossible to say what, when presented with a set of choices, an individual would select. The notion of rationality is therefore central to any understanding of microeconomics.

Measurement[edit]

There are no real methods of measuring utility outside of a purely theoretical framework. An option giving 100 utils has no real interpretation, except that it is preferred to an option giving 50, and is less preferred than an option giving 101. The numbers used to model utility are only determined in the functional form of the model from which they result. It is meaningless, for example, to ask "how much utility does this apple give you?" It could only be meaningful to ask, "Would you prefer an apple or an orange?" in any non-theoretical framework.

Being "better off"[edit]

In microeconomic theory, we often say that an individual is made "better off" if one circumstance is preferred to another (that is, gives greater utility), and that individual is put into it. A simple example would be giving a child a cookie. Assuming the child enjoys cookies, the child is "better off" with the cookie than without it. Again, in this example we say he is "better off" only in terms of his preferences, rather than in terms of his health, etc.