What does utility in economics mean?

The utility explains how individuals and economies aim to get the optimal satisfaction from receiving a product, a good or a service when it comes to the scarcity of it. It is measured in units of satisfaction called utils,and is divided into two categories, total utility and marginal utility. Total utility is the aggregate sum of an individual’s satisfaction obtained from the consumption of a certain quantity of goods and services in an economy. Therefore it increases with increasing consumption. Marginal utility, on the other hand, is the additional satisfaction gained by an extra consumption unit, so it decreases with any additional units consumed. The law of decreasing marginal utility gives an understanding of the law of supply and demand. It depends mainly on the preferences of a particular individual since one asset can be preferred more than another by different people.

History of utility study

Although over the years it has been noted that utility cannot be measured directly, two utility functions have been developed, the cardinal and ordinal forms of utility. Cardinal utility is used when the difference in utility size is treated as a significant amount while in ordinal utility, the differences make no sense with regards to the strengths of preferences. Several economists have used different approaches to utility. The father of utilitarianism, Jeremy Bentham, refuted Adam Smith’s principle of utility, which depended mainly on personal interest and natural identity. Bentham agreed that people were selfish but denied any natural harmony to utility, so individuals had to look for artificial harmony. Alfred Marshall stated that the total usefulness of a person derived from the goods increases at a decreasing rate and the desire to make the product is measured by an individual’s willingness to pay for it.

Relevant applications

The tracking of a combination of two products that an individual or a company would accept to maintain a certain degree of satisfaction produces the indifference curve on a graph. Therefore, economists use utility and indifference curves to understand the demand curves. When the utility is coupled with commodity or production constraints, it can be used to analyze a resource allocation state where it is impossible to make someone feel good without making the other worse. In finance, it is linked to risk measures and to the indifferent price index for an asset.

Praise and criticism of the concept

The various utility applications employed by different economists have their inherent advantages and disadvantages. Among these, the criticisms of utilitarianism include that it involves an individual’s feelings and is difficult to apply, since the effects on the general population cannot be easily calculated and quantified. Modern economists have criticized Marshall’s utility analysis because of his belief that utility can be measured in cardinal numbers. Marshall’s belief that the utility of assets is measured in monetary terms that were considered irrational as the marginal utility of money should remain unchanged. Utility was of great importance as human desires could be satisfied by choosing goods based on the utility it provides.

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