Introduction to Microeconomics. Microeconomics vs. Supply and Demand Basics. Microeconomics Concepts. Economy Economics. Table of Contents Expand. What Is Utility Function? Understanding Utility Function. How to Calculate a Utility Function. Example of Utility Function. Pros and Cons of Utility Function. Utility Function FAQs. The Bottom Line. Key Takeaways In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility represents the satisfaction that consumers receive for choosing and consuming a product or service.
Economists track consumer choices to ascertain one product's utility versus another and assign a numerical value to that utility. Company executives research consumers' utility to guide the company's sales and marketing plans, advertising, and new product offerings.
Ordinal utility ranks choices by preference, whereas cardinal utility measures the utility received from a choice. Important Utility function is essentially a "model" used to represent consumer preferences, so companies often implement them to gain an edge on the competition. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.
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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Articles. Macroeconomics What are the different ways that utility is measured in economics? Microeconomics Examples of the Law of Demand. Microeconomics What is the concept of utility in microeconomics? Partner Links. Related Terms Total Utility Total utility is the aggregate summation of satisfaction or fulfillment that a consumer receives through the consumption of goods or services.
Utility Definition Utility is an economic term referring to the satisfaction received from consuming a good or service. Above the Margin: Understanding Marginal Utility Marginal utility is the additional satisfaction a consumer gets from having one more unit of a good or service.
Marginal Benefit A marginal benefit is the added satisfaction or utility a consumer enjoys from an additional unit of a good or service. Revealed Preference Definition Revealed preference states that consumer behavior, if their income and the item's price are held constant, is the best indicator of their preferences. Consumer Theory Definition Consumer theory is a branch of microeconomics, studying how people decide what to spend their money on based on their preferences and budget constraints.
We think about what will make us the happiest; we think about what things cost; we think about buying a little more of one item and giving up a little of something else; we choose what provides us with the greatest level of satisfaction. The vocabulary of comparing the points along a budget constraint and total and marginal utility is just a set of tools for discussing this everyday process in a clear and specific manner.
It is welcome news that specific utility numbers are not central to the argument, since a good utilimometer is hard to find. Do not worry—while we cannot measure utils, by the end of the next module, we will have transformed our analysis into something we can measure—demand.
Economic analysis of household behavior is based on the assumption that people seek the highest level of utility or satisfaction.
Individuals are the only judge of their own utility. In general, greater consumption of a good brings higher total utility. However, the additional utility received from each unit of greater consumption tends to decline in a pattern of diminishing marginal utility. The utility-maximizing choice on a consumption budget constraint can be found in several ways. You can add up total utility of each choice on the budget line and choose the highest total. You can choose a starting point at random and compare the marginal utility gains and losses of moving to neighboring points—and thus eventually seek out the preferred choice.
Alternatively, you can compare the ratio of the marginal utility to price of good 1 with the marginal utility to price of good 2 and apply the rule that at the optimal choice, the two ratios should be equal:. Praxilla, who lived in ancient Greece, derives utility from reading poems and from eating cucumbers. Praxilla gets 30 units of marginal utility from her first poem, 27 units of marginal utility from her second poem, 24 units of marginal utility from her third poem, and so on, with marginal utility declining by three units for each additional poem.
Praxilla gets six units of marginal utility for each of her first three cucumbers consumed, five units of marginal utility for each of her next three cucumbers consumed, four units of marginal utility for each of the following three cucumbers consumed, and so on, with marginal utility declining by one for every three cucumbers consumed.
A poem costs three bronze coins but a cucumber costs only one bronze coin. Praxilla has 18 bronze coins. Start off with the choice of zero poems and 18 cucumbers, and calculate the changes in marginal utility of moving along the budget line to the next choice of one poem and 15 cucumbers. Compare the marginal utility of the two goods and the relative prices at the optimal choice to see if the expected relationship holds. If we choose zero through five round trips column 1 , the table below shows how many phone minutes can be afforded with the budget column 3.
The total utility figures are given in the table below. Adding up total utility for round trips and phone minutes at different points on the budget line gives total utility at each point on the budget line.
The highest possible utility is at the combination of one trip and minutes of phone time, with a total utility of The first step is to use the total utility figures, shown in the table below, to calculate marginal utility, remembering that marginal utility is equal to the change in total utility divided by the change in trips or minutes.
Note that we cannot directly compare marginal utilities, since the units are trips versus phone minutes. We need a common denominator for comparison, which is price. Dividing MU by the price, yields columns 4 and 8 in the table below. Start at the bottom of the table where the combination of round trips and phone minutes is 5, 0. This starting point is arbitrary, but the numbers in this example work best starting from the bottom. Suppose we consider moving to the next point up.
At 4, 40 , the marginal utility per dollar spent on a round trip is The marginal utility per dollar spent on phone minutes is We keep trading round trips for phone minutes until we get to 1, , which is the best we can do. Skip to content Chapter 6. Consumer Choices. Learning Objectives By the end of this section, you will be able to:. Calculate total utility Propose decisions that maximize utility Explain marginal utility and the significance of diminishing marginal utility.
So: Step 1. In short, the general rule shows us the utility-maximizing choice. Self-Check Questions Jeremy is deeply in love with Jasmine. To make his preferred choice, Jeremy uses a handy utilimometer that measures his total utility from personal visits and from phone minutes. Round Trips Total Utility Phone Minutes Total Utility 0 0 0 0 1 80 20 2 40 3 60 4 80 5 6 7 8 9 10 Table 6.
Review Questions Who determines how much utility an individual will receive from consuming a good? The implication is that there is no way to compare utility between consumers. One important concept related to cardinal utility is the law of diminishing marginal utility , which states that at a certain point, every extra unit of a good provides less and less utility. While a consumer might assign the first basket of bananas a value of 10 utils, after several baskets, the additional utility of each new basket might decline significantly.
The values that are assigned to each additional basket can be used to find the point at which utility is maximized or to estimate a customer's demand curve. An alternative way to measure utility is the concept of ordinal utility , which uses rankings instead of values. The benefit of using rankings is that the subjective differences between products and between consumers are eliminated, and all that remains are the ranked preferences.
One consumer might like mangoes more than bananas, and another might prefer bananas over mangoes. These are comparable, if subjective preferences. Lastly, utility is used in the development of indifference curves , which represent the combination of two products that a consumer values equally and independently of price.
For example, a consumer might be equally happy with three bananas and one mango or one banana and two mangoes. As a result, three bananas plus one mango and one banana plus two mangoes represent two points on the consumer's indifference curve.
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