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 the amount 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 is the concept of utility in microeconomics?

    Read about the concept of utility in microeconomics, and why economists disagree about the usefulness of cardinal utility ... Read Answer >>
  2. 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 >>
  6. What are the main benchmarks that track the performance of the utilities sector?

    Learn about the main benchmarks that track the performance of the utilities sector, such as the Dow Jones Industrial Average ... Read Answer >>
Related Articles
  1. 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.
  2. Insights

    Explaining Marginal Utility

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

    How Utilities ETFs Deal With Rising Rates

    Utilities stocks and ETFs may be vulnerable to rising interest rates, but there are other factors to consider.
  5. 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.
  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. Insights

    What's Utility?

    Utility has two meanings depending on the context.
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. Expected Utility

    An economic term summarizing the utility that an entity or aggregate ...
  5. Utility Revenue Bond

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

    An exchange-traded fund that invests in companies which generate ...
Hot Definitions
  1. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  2. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  3. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  4. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  5. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  6. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
Trading Center