Utility in Microeconomics: Origins and Types

Utility is a loose and sometimes controversial topic in microeconomics. Generally speaking, utility refers to the degree of pleasure or satisfaction (or removed discomfort) that an individual receives from an economic act. An example would be a consumer purchasing a hamburger to alleviate hunger pangs and to enjoy a tasty meal, providing her with some utility.

All economists would agree that the consumer has gained utility by eating the hamburger. Most economists would agree that human beings are, by nature, utility-maximizing agents; human beings choose between one act or another based on each act's expected utility. The controversial part comes in the application and measurement of utility.

The Origins of Utility

The development of utility theory begins with a logical deduction. Voluntary transactions only occur because the trading parties anticipate a benefit (ex-ante); the transaction wouldn't happen otherwise. In economics, "benefit" means receiving more utility.

Economists also say that human beings rank their activities based on utility. A laborer chooses to go to work rather than skip it because he anticipates his long-run utility to be greater as a result. A consumer who chooses to eat an apple rather than an orange must value the apple more highly, and thus anticipates more utility from it.

Utility took hold in economics during the marginalist revolution, which tried to formalize and mathematize economics based on incremental changes. Because mainstream economists today have adopted a rational actor perspective, where their models assume that individuals are driven entirely by self-interest utility maximization, the concept of utility has been made prominent in microeconomics.

Cardinal and Ordinal Utility

The ranking of utility is known as an ordinal utility. It is not a controversial topic; however, most microeconomic models also use cardinal utility, which refers to measurable, directly comparable levels of utility.

Cardinal utility is measured in units called "utils" to transform the logical to the empirical. The ordinal utility might say that, ex-ante, the consumer prefers the apple to the orange. Cardinal utility might say that the apple provides 80 utils while the orange only provides 40 utils. Economists sometimes employ what is known as an indifference curve to elucidate the cardinal utility of two or more goods in graphical form.

Marginal Utility

Marginal utility looks at the added satisfaction that somebody gains (or loses) from consuming just one additional unit of a good or service. For instance, eating a hamburger when hungry provides a lot of utility. Eating a second hamburger perhaps a bit less satisfaction. A third hamburger may even lower utility since you're already quite full.

The law of diminishing marginal utility describes this effect, where adding one more unit of something typically results in fewer and fewer gains in utility for the consumer.

The Usefulness of Utility

Utility theory has been quite useful in understanding the economic action of individuals, households, and firms—but only in broad strokes. In reality, people may eat a third hamburger for reasons that elude the rational actor assumption of standard economic models. For instance, a leftover hamburger may be considered wasteful food, and in order to prevent waste, it is eaten. This more ethical or qualitative evaluation of "utility" is difficult to capture in mathematical models or formulae.

Behavioral economics has also revealed time and again how economic actors deviate from rational expectations in everyday life and fail to maximize utility. Moreover, empirical work shows that people have inconsistent preferences. While somebody may prefer apples to oranges this week, next week oranges may be what is craved.

As a result of these and other factors, some have questioned the usefulness of utility in practice.

The Bottom Line

Even though no economist truly believes that utility can be measured this way, some still consider utility a useful tool in microeconomics. Cardinal utility places individuals on utility curves and can track declines in marginal utility across time. Microeconomics also performs interpersonal comparisons with cardinal utility.

Other economists argue that no meaningful analysis can come out of imaginary numbers and that cardinal utility—and utils—is logically incoherent.