Economics Basics: Utility

 

We have already seen that a primary focus of economics is to understand behavior given the problem of scarcity: the problem of fulfilling the unlimited wants of humankind with limited or scarce resources. Because of scarcity, economies need to allocate their resources in such a way that everything ends up where it ought to. Underlying the laws of demand and supply is the concept of utility, which represents the advantage, pleasure, or fulfillment a person gains from obtaining or consuming a good or service.
Utility, then, is used to explain how and why individuals and economies aim to gain optimal satisfaction in dealing with scarcity. The idea of utility as a guiding force of human action is not new, and was established in economic theory in the 1700’s and 1800’s in Europe and especially in England thanks to thinkers such as Adam Smith, John Stuart Mill, and Jeremy Bentham who believed that people are driven to find pleasure and avoid pain. The viewpoint that people maximize utility, known as utilitarianism, has been taken up by the field of economics, but also criticized by some who claim that pleasure and freedom from pain are not the only goals that matter in life.
Utility is an abstract theoretical concept rather than a concrete, observable quantity. The units to which we assign an amount of utility (known as utils), therefore, are arbitrary, representing a relative value. Total utility is the aggregate sum of satisfaction or benefit that an individual gains from consuming a given amount of goods or services in an economy. The amount of a person's total utility thus corresponds to the person's level of consumption. Usually, the more that a person consumes, the larger his or her total utility will be. Marginal utility is the additional bit of satisfaction, or amount of utility, gained from each extra unit of consumption. For example, from eating just one more cookie.
Although the total amount of utility gained usually increases as more of a good is consumed, the marginal utility usually decreases with each additional increase in the consumption of a good. This decrease demonstrates the law of diminishing marginal utility. Because there is a certain maximum threshold of satisfaction, the consumer will no longer receive the same pleasure from consumption once that threshold is crossed. In other words, total utility will increase at a slower pace as an individual increases the quantity consumed. For example, the pleasure of eating the first cookie is much greater than the pleasure received from eating the tenth or eleventh cookie in a sitting.
Moving on from cookies, let us now consider a chocolate bar. Say that after eating one chocolate bar your sweet tooth has been completely satisfied. Your marginal utility (and total utility) after eating one chocolate bar will be quite high. But if you eat more chocolate bars, the pleasure of each additional chocolate bar will be less than the pleasure you received from eating the one before - probably because you are starting to feel full or you have had too many sweets for one day. In fact, if you were to eat 5 or more chocolates, you may begin to experience pain and not pleasure.
This table shows that total utility will increase at a much slower rate as marginal utility diminishes with each additional bar. Notice how the first chocolate bar gives a total utility of 70 but the next three chocolate bars together increase total utility by only 18 additional units.
The law of diminishing marginal utility helps economists understand the law of demand and the negative sloping demand curve. The less of something you have, the more satisfaction you gain from each additional unit you consume; the marginal utility you gain from that product is therefore higher, giving you a higher willingness to pay more for it. Prices are lower at a higher quantity demanded because your additional satisfaction diminishes as you demand more.
In order to determine what a consumer's utility and total utility are, economists turn to consumer demand theory, which studies consumer behavior and satisfaction. Economists assume the consumer is rational and will thus maximize his or her total utility by purchasing a combination of different products rather than more of one particular product. Thus, instead of spending all of your money on three chocolate bars, which has a total utility of 85, you should instead purchase the one chocolate bar, which has a utility of 70, and perhaps a glass of milk, which has a utility of 50. This combination will give you a maximized total utility of 120 but at the same cost as the three chocolate bars.