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Utility Theory: Definition, Examples & Economics

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  • 0:04 Definition of Utility
  • 1:05 Cardinal Utility
  • 2:13 Ordinal Utility
  • 3:07 Utility and Demand Curves
  • 4:01 Lesson Summary
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Lesson Transcript
Instructor
James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

Expert Contributor
Joseph Shinn

Joe has a PhD in Economics from Temple University and has been teaching college-level courses for 10 years.

This lesson will explain the economic concept of utility and the two ways it is measured. The usefulness of utility in the theoretical derivation of demand curves is also explained.

Definition of Utility

When Marie makes her weekly trip to the grocery store, she'll be making many quick decisions about what she buys. She probably has a number in her head that is the most she wants to spend on this trip. That means her objective will be to get the most happiness or satisfaction from every dollar she is going to spend.

We all know that the concept of happiness is impossible to quantify or put into numerical terms, but economists will try anyway! That brings us to the economic concept of utility. Utility is the amount of satisfaction that you will get from the consumption of a product or service.

Economists use an abstract measure for the amount of satisfaction you receive from something; it is called a 'util'. A util is an abstraction because it isn't something in the physical world like an inch or a pound. It is something inside your head, it represents one unit of satisfaction or happiness. You might get 25 utils of satisfaction from eating a bowl of ice cream while someone else would only get 5 utils of satisfaction.

Cardinal Utility

So how is Marie going to maximize her satisfaction on that grocery store trip? First she knows that she does not want to spend over $100. That means lots of choices about the combination of grocery items that she puts in her cart that will give her the most satisfaction and doesn't go over $100. She never studied economics and has no idea what utility is, but that is exactly what she is going to use to solve her puzzle!

Utility can be measured in two ways; one is called cardinal. It's based on the cardinal counting numbers like 1, 2, 3, 4. When Marie uses cardinal utility, she will subjectively place a value on the grocery items in the store by assigning a numerical value to them that represents the amount of satisfaction or happiness she will get when she eats it. Her numbers might look like this:

  • Roast beef slices: 40 utils
  • Fish fillets: 60 utils
  • Chicken breasts: 75 utils

She is going to choose the chicken because it will provide the most utility. She will also be willing to pay more for chicken than she would for fish or beef.

Ordinal Utility

Now, it would be very unusual to find someone scribbling down measures of utility in a grocery store. It is far more likely that she would use the other measure of utility: ordinal.

Ordinal utility means ranking items under consideration from most satisfaction to the least. Many economists believe that consumers do this in their heads when they make purchase decisions. Once Marie has enough items in her cart to cover the main courses for her meals, it's time for the fun part: that's when she gets to buy the desserts and snacks!

She loves ice cream. She love fudge swirl the most, followed by chocolate, then strawberry. This will determine how much she is willing to pay for these flavors as such:


She will pay the most for the flavors that give her the most utility!
flavor chart


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Additional Activities

Examples of Cardinal and Ordinal Utility



Part 1:


Define utility, cardinal utility, and ordinal utility.



Part 2:


For each of the following examples, describe if cardinal or ordinal utility is being applied. Your responses should include an explanation about why you chose the answer.

  • You go to a restaurant with friends and am looking over the menu. Two items that catch your attention are the steak and the lobster. After thinking it over, you realize that you will get more enjoyment from eating the lobster than the steak, so you decide to order the lobster.
  • You go to a car dealership to buy a new car. You are interested in both the Ford Focus and the Ford Fiesta. Before knowing the prices and after looking at both of them and taking them both for test drives, you decide that you would be willing to pay up to $30,000 for the Focus and $28,000 for the Fiesta. After finding out that they are both the same price, you decide to purchase the Ford Focus.
  • You goto Taco Bell and eat 3 tacos. After you finish, you realize that you are still hungry and are trying to decide if you should purchase another taco or a burrito. Because you already ate 3 tacos, you determine that you would only receive 10 units of satisfaction for the fourth taco, but would receive 30 units for the burrito (the first one consumed). Therefore, he decides to buy the burrito.

Part 3

Why does a demand curve slope downward? Please explain why in no more than 100 words.

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