Utility

This article is about the economic concept. For other uses of the term Utility, please see Utility (disambiguation).

The concept of utility is used as an organising device for presenting the rationales of many of the theories of microeconomics. Although it has no explanatory power in itself, it has proved useful as a means of developing explanations of economic behaviour.

Definition

The utility of an item to a person is conceived as a measure of how much satisfaction he gets from it or, equivalently, as a measure of how much he wants it.

Measurement

Utility is not a measure that can be expressed as a numerical quantity. Although how much a person wants product can be expressed as the amount of some other product that he is willing to give in exchange for it, that amount is not an absolute measure of its utility to him because it depends upon how much of both items he already has. There is, in fact, no logical possibility of a numerical measure of utility: it is necessarily an “ordinal measure” that can be used only for the purpose of comparison. Thus, although a person can rank the utilities that he gets from two different products in order of magnitude, he cannot assign a numerical magnitude to the utility he gets from either; and although he may find that getting more of an item increases his utility, he cannot say by how much. Also, since utility is conceived as a purely personal reaction to a product, and since no-one can know what goes on in another person's mind, it is impossible to make inter-personal comparisons of utility.

Origins and development

The term utility was mentioned by the classical economists but its present-day usage is generally attributed to its conception towards the end of the nineteenth century by William Stanley Jevons . It was conceived independently at about the same time by Alfred Marshall who expounded it in words and in mathematics in his Principles of Economics and deduced from it the concept of the demand curve. Those derivations were further developed and extended in the early twentieth century by Francis Edgeworth and Vilfredo Pareto. The theory that emerged has no empirical content, having been derived entirely by verbal and mathematical deduction from introspective postulates, but it has been widely used to construct economic models that have themselves been subject to empirical testing.

Indifference curve analysis

In microeconomic theory, the concept of utility is combined with assumptions about human psychology summed up by Alfred Marshal in his statement that "there is an endless variety of wants but a limit to each separate want". Stated more formally, the law of diminishing marginal utility expresses the assumption that the increase in utility that a consumer gets from the same incremental amount of a product diminishes with every increase in the amount of that product that he already has. It is the basis of the theory of consumer choice known as indifference curve analysis. Stated in full, the assumptions of that theory are:

• that consumer preferences are consistent so that if A is preferred to B and B is preferred to C then A is preferred to C (formally termed "transitivity");
• that a consumer who has a large amount of A and a relatively small amount of B would be willing to give up a relatively large amount of A in exchange for a given increment of B, but that the amount of A that he would be willing to give up diminishes with every increase in the amount of B that he already has (termed the diminishing marginal rate of substitution); and,
• that a consumer's total utility increases with every increase in the amount that he has of either product (sometimes termed "non-satiety").

Indifference curve theory is customarily presented as a set of curves, each being a plot of an amount of A against the amount of B that the consumer would be willing to exchange it. The first assumption is represented by the fact that the curves do not intersect, and the second assumption by the fact that they slope downwards from left to right and are concave when viewed from above. The third assumption is embodied in the explanation that the further a curve is from the origin, the higher is the level of utility that it represents.

By taking one of the two products to be money, indifference curve analysis can be used to derive the concept of the downward-sloping demand curve that is used in connection with the theory of supply and demand.

Utility and Welfare

The terms "utility" and "welfare" are generally used synonymously, but the concept is normally termed welfare when referring to the well-being of a community in the context of welfare economics.