5.1 : Concept of Utility

Utility

Utility is the satisfaction a customer gets from using a product. It refers to the level of satisfaction a consumer experiences. Generally, the term utility carries a wide range of implications, roughly translating to "benefit," "well-being," or "happiness." Consumers derive "utility" from using products that give them satisfaction. Utility can be measured either cardinally or ordinally.

Cardinal Utility

When measured cardinally, some economists used monetary units, and others suggested that utility be measured with a hypothetical unit called 'utils.' It quantifies the satisfaction a consumer derives from consuming products. The cardinal utility approach assumes that consumers can assign specific numerical values to measure their level of satisfaction. For example, a consumer might derive 20 utils from consuming an apple and 40 utils from consuming a banana. This implies the consumer gets twice the satisfaction from a banana than an apple.

Ordinal Utility

Ordinal utility represents a consumer's relative satisfaction from consuming goods or services. Unlike cardinal utility, which attempts to assign specific numerical values to utility, ordinal utility merely ranks preferences between goods as either better, worse, or the same. It assumes that consumers can rank their preferences for different products, but they cannot quantify the exact difference between them. For example, a consumer might prefer apples to bananas and bananas to cherries, but this does not tell us how much one is preferred over the other.

Measuring utility in numerical terms can be challenging due to its subjective nature. The relative utility of one good to another can be very different across individuals. Further, the total happiness (utility) generated by consuming a particular good may also vary considerably across individuals. Hence, while cardinal utility provides a theoretical framework, many economists prefer to use the concept of ordinal utility, which involves simply ranking preferences without assigning numerical values.