What Does Utility Mean In Economics?
Utility explains how individuals and economies aim to gain optimal satisfaction from receiving a product, good, or service when dealing with scarcity thereof. It is measured in units of satisfaction called utils, and is divided into two categories, the total utility and the marginal utility. Total utility is the aggregate sum of an individual’s satisfaction gained from consuming a given amount of goods and services in an economy. Therefore it increases as consumption increases. Marginal utility, on the other hand, is the additional satisfaction gained from an extra unit of consumption thus it decreases with any additional unit consumed. The law of diminishing marginal utility gives an understanding of the law of demand and supply. It is mainly dependent on the preferences of a particular individual as one good could be preferred more than another by different people.
History of the Study of Utility
Though over the years it has been noted that utility cannot be measured directly, and two utility functions have been developed, the cardinal and ordinal forms of utility. The cardinal utility is used when the magnitude difference of utility is treated as a significant quantity while in ordinal utility, the differences are meaningless in regards to the strengths of the preferences. Various economists used different approaches in regards to utility. The father of utilitarianism, Jeremy Bentham, refuted Adam smith’s principle of utility which mainly depended on one’s self-interest and natural identity. Bentham was in agreement that individuals were self-interested but denied any natural harmony towards utility thus individuals should seek an artificial harmony. Alfred Marshall stated that the total utility of a person derived from commodity increases at a decreasing rate and the desire to achieve the product is measured by the willingness of an individual to pay for it.
Relevant Applications
The plotting of a combination of two commodities that an individual or society would accept to maintain some degree of satisfaction yields the indifference curve on a graph. Therefore, utility and indifference curves are used by economists to understand demand curves. When utility is coupled up with commodity or production constraints, it can be used to analyze a state of resource allocation where it is impossible to make someone better off without making the other worse off. In finance, it is related to risk measures and the indifferent price index for an asset.
Praises and Criticisms of the Concept
The various applications of utility employed by different economists have their own inherent benefits and drawbacks. Among them, utilitarianism’s criticisms include that it involves an individual’s sentiments and is hard to apply, as effects on the general population cannot be easily calculated and quantified. Modern economists have criticized Marshall's utility analysis due to his belief that utility can be measured in cardinal numbers. Marshall’s belief that utility of goods is measured in monetary terms which have been considered irrational as the marginal utility of money should remain invariant. The utility has been of great importance as human wants could be satisfied by choosing of commodities depending on the utility it gives. For instance, choosing between taking water and milk, one compares the utility he or she will derive from each product and makes a choice.
