Utility Function Definition, Example, and Calculation

Value of money always changes, therefore, correct measurement is not possible. If I am ready to pay Rs. 1500 for a watch and Rs. 2,000 for a Radio. Then I can say that I derive utility from that watch up to the value of Rs. 1500; and from Radio up to the value of Rs. 2,000. Making a product available in a wide variety of stores and locations is considered an added value because it’s more convenient. Apple (AAPL) sells iPhones and laptops through its retail stores but it also offers its products through other electronics retailers such as Best Buy (BBY).

3 Relating Utility Functions and Indifference Curve Maps

For example, economists often examine budget constraints over a consumer’s lifetime. A consumer may in some years save for future consumption and in other years borrow on future income for present consumption. Whatever the time period, a consumer’s spending will be constrained by his or her budget.

Concept Quiz

Understanding marginal utility helps assess the change in a person’s perception of a commodity. It refers to the sum of a person’s satisfaction from consuming all units of a certain commodity. The second one is marginal utility, wherein additional utility is gained as a person consumes additional units of a product or service.

1. Ordinal utility reveals that the judges preferred contestant A over contestants B and C and contestant B over C.
2. Consider lenders who offer favorable financing terms for owning a car, appliance, or home.
3. Then I can say that I derive utility from that watch up to the value of Rs. 1500; and from Radio up to the value of Rs. 2,000.
4. Marginal utility is the utility derived from the last or marginal unit of consumption.
5. Marginal utility measures the change in utility when the rate of consumption changes (i.e., how much more satisfaction is gained by consuming another unit of a good or service).

Under the concept of total utility, it is assumed that Mark’s satisfaction level varies for each slice he eats. Total utility is the aggregate amount of all utilities a person gained from consuming a certain amount of a product or service within their income level or budget constraint. For example, you consider whether you should buy a steak or a fish fillet. Your cardinal utility is denoting that steak is the option that will give you greater satisfaction.

Recalling that utility includes every element of a decision, this assumption is not particularly difficult to accept. This should not necessarily be taken to mean that individuals who fail to quantify and measure every decision they make are behaving irrationally. Rather, this means that a rational individual is one who types of utility in economics always selects that option that they prefer the most. Economists assume that consumers behave in a manner consistent with the maximization of utility.

The concept of diminishing marginal utility is central to the analysis of consumer equilibrium. Once the marginal utility drops below this level, it no longer makes sense for the consumer to pursue marginal units of the good. Economists use the concept of marginal utility to explain how consumers make choices to maximize their total utility, given their preferences and budget constraints. In theory, consumers will allocate their income to goods and services in a way that maximizes their overall satisfaction. For instance, if you have disposable income of $100 this month, it is most likely that you will allocate those funds to maximizing whatever increases your utility.

1 Utility Functions

So while the last bite might still be good, it is probably not as satisfying as the first. Utility is a term used by economists to describe the measurement of “useful-ness” that a consumer obtains from any good or service. Utility may measure how much one enjoys a movie or the sense of security one gets from buying a deadbolt. Some examples include the utility from eating an apple, from living in a certain house, from voting for a specific candidate, or from having a given wireless phone plan.

We keep eating M&M until the rate of additional utility per cent is equal, say 6, for M&M and Doritos. Hence, the combination of M&M and Doritos making that happen is the best (optimal in economic terms). The formula shows that every dollar spent on a product or service should bring the same amount of marginal utility. This way, the consumer has spent their money well and can remain within the budget they created and maintain.