A:

In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility is measured in units called utils, which represent the welfare or satisfaction of a consumer from consuming a certain number of goods. Because satisfaction or welfare is a highly abstract concept, economists measure utility in terms of revealed preferences by observing consumer choices and creating an ordering of consumption baskets from least desired to the most preferred. Economists create a parametric functional form for the utility function based on the assumption of observed consumer behavior, with a number of goods as variables and certain fixed parameters. After that, utility is calculated by substituting certain numerical values for the consumption of goods in the utility function.

## Utility Function

In economics, the utility function measures welfare or satisfaction of a consumer as a function of consumption of real goods, such as food, clothing and composite goods rather than nominal goods measured in nominal terms. Utility function is widely used in the rational choice theory to analyze human behavior.

## Utility Calculation Example

To postulate the utility function, economists typically make assumptions about the human preferences for different goods. For example, in certain situations, tea and coffee can be considered perfect substitutes of each other and the appropriate utility function must reflect such preferences with a utility form of u(c, t) = c + t, where "u" denotes the utility function and "c" and "t" denote coffee and tea. A consumer who consumes 1 pound of coffee and no tea derives a utility of 1 util.

RELATED FAQS
1. ### What kind of investors buy utility stocks?

Take a look at why income investors like utilities, why value investors might like utilities and why growth investors tend ... Read Answer >>

3. ### What are the different ways that utility is measured in economics?

Learn about the two methods used to measure the concept of utility and how utility influences other economic models of consumer ... Read Answer >>
4. ### What are the top investing strategies for investing in the utility sector?

Employ the right strategies when investing in the utility sector, and you can see consistent returns with less risk than ... Read Answer >>
5. ### What does marginal utility tell us about consumer choice?

Learn how marginal utility influences consumer choice under the law of diminishing marginal utility and consumer decisions ... Read Answer >>

Related Articles
1. Insights

### Explaining Marginal Utility

Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service.
2. Investing

### The Debt Report: The Utilities Sector

Discover how blue chip U.S. utilities companies are using debt, and why it was important for the industry to deleverage after the financial crisis.
3. Investing

### 5 Popular Utilities ETFs in 2016 (XLU, NEE)

Discover how the five most popular utilities ETFs for 2016 can add growth and income to your portfolio. Four of these utilities ETFs outperformed the S&P 500.
4. Investing

### ETF Flows: Utilities ETFs Stand Tall in 2016

Find out which utilities exchange-traded funds (ETFs) have benefited the most from the huge surge in fund inflows in the early part of 2016.
5. Insights

### What's Utility?

Utility has two meanings depending on the context.
6. Investing

### The Top 5 Utility ETFs for 2016 (XLU, IDU)

Discover the top utility company ETFs, and learn more about how you can get exposure to water, electricity and natural gas utility companies.
7. Investing

### Utilities ETFs to Date 2016 Performance Review (UPW, FXU)

Discover the best and worst performing exchange-traded funds (ETFs) within the domestic and international utilities sector year-to-date.
8. Investing

### A Surprising Sector Is Leading in August

While other sectors sag, utilities are heating up in August.
RELATED TERMS
1. ### Total Utility

The aggregate level of satisfaction or fulfillment that a consumer ...
2. ### Utility

1. An economic term referring to the total satisfaction received ...
3. ### Utilities Sector

A category of stocks for utilities such as gas and power. The ...
4. ### Utility Revenue Bond

A type of municipal bond that is issued to finance utility projects, ...
5. ### Electric Utilities Industry ETF

An exchange-traded fund that invests in companies which generate ...
6. ### Expected Utility

An economic term summarizing the utility that an entity or aggregate ...
Hot Definitions
1. ### Private Placement

The sale of securities to a relatively small number of select investors as a way of raising capital.
2. ### AAA

The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
3. ### Backward Integration

A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
4. ### Pari-passu

A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
5. ### Interest Rate Swap

An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for ...
6. ### Custodian

A financial institution that holds customers' securities for safekeeping so as to minimize the risk of their theft or loss. ...