Utility

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What is 'Utility'

"Utility" is an economic term introduced by Daniel Bernoulli referring to the total satisfaction received from consuming a good or service. The economic utility of a good or service is important to understand because it will directly influence the demand, and therefore price, of that good or service. A consumer's utility is hard to measure, however, but it can be determined indirectly with consumer behavior theories, which assume that consumers will strive to maximize their utility.

BREAKING DOWN 'Utility'

Classical economists operate under the assumption that all utilities can be measured as a hard number. To help with this quantitative measurement of satisfaction, the designation of a util was created to represent the amount of psychological satisfaction a specific good or service generates, for a subset of people in various situations.

If, for example, an individual judges that a piece of pizza will yield 10 utils and that a bowl of pasta will yield 12 utils, that individual will know that eating the pasta will be more satisfying. For the producers of pizza and pasta, knowing that the average bowl of pasta will yield 2 additional utils will help them price pasta slightly higher than pizza.

Additionally, utils can decrease as the number of products or services as consumption increases. The first slice of pizza may yield 10 utils, but as more pizza is consumed, the utils may decrease as people become full. This will help consumers understand how to maximize their utility by allocating their money between multiple types of goods and services as well as help companies understand how to structure tiered pricing.

The Definition of Total Utility

Total utility (TU) is defined as the total amount of satisfaction that a person can receive from the consumption of all units of a specific product or service. Using the example above, if a person can only consume three slices of pizza and the first slice of pizza consumed yields 10 utils, the second slice of pizza consumed yields 8 utils and the third slice yields 2 utils, the total utility of pizza would be 20 utils.

TU can be infinite. Its upper boundary is set by the total number of a good or service available for consumption by a consumer.

The Definition of Marginal Utility

Marginal utility (MU) is defined as the additional utility gained from the consumption of one additional unit of a good or service. Using the same example, if the utility of the first slice of pizza is 10 utils and the utility of the second slice is 8 utils, the MU of eating the second slice is 8 utils. If the utility of a third slice is 2 utils, the MU of eating that third slice is 2 utils.

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