Customers use many products that give them pleasure or satisfaction.
Utility refers to the measure of satisfaction or well-being that a consumer derives from consuming a good or service.
Consider an environmentally conscious customer. She finds utility in a small car that reduces the trapped heat in urban areas.
If she is health-conscious, she may use a smartwatch. The watch provides utility by tracking how often she stands, how much she moves, and the duration of her exercise.
Economists measure utility in two ways. They can do it either cardinally or ordinally.
When utility is measured cardinally, it can be quantified. Here, a hypothetical unit of measurement called utils is used.
For instance, it could be said that a customer gets ten utils of satisfaction from watching a movie and five utils of satisfaction from eating a burger.
In modern economics, the cardinal utility approach is outdated and not used to measure utility.
In the ordinal approach, customers can rank their preferences. However, customers do not express the exact magnitude of the difference in their utility between the two products.
For example, a customer can say she gets more satisfaction from watching a movie than eating a burger.
5.1 Concept of Utility
Utility
Utility is the satisfaction a customer gets from using a product. It refers to the level of satisfaction a consumer experiences. Generally, the term utility carries a wide range of implications, roughly translating to "benefit," "well-being," or "happiness." Consumers derive "utility" from using products that give them satisfaction. Utility can be measured either cardinally or ordinally.
Cardinal Utility
When measured cardinally, some economists used monetary units, and others suggested that utility be measured with a hypothetical unit called 'utils.' It quantifies the satisfaction a consumer derives from consuming products. The cardinal utility approach assumes that consumers can assign specific numerical values to measure their level of satisfaction. For example, a consumer might derive 20 utils from consuming an apple and 40 utils from consuming a banana. This implies the consumer gets twice the satisfaction from a banana than an apple.
Ordinal Utility
Ordinal utility represents a consumer's relative satisfaction from consuming goods or services. Unlike cardinal utility, which attempts to assign specific numerical values to utility, ordinal utility merely ranks preferences between goods as either better, worse, or the same. It assumes that consumers can rank their preferences for different products, but they cannot quantify the exact difference between them. For example, a consumer might prefer apples to bananas and bananas to cherries, but this does not tell us how much one is preferred over the other.
Measuring utility in numerical terms can be challenging due to its subjective nature. The relative utility of one good to another can be very different across individuals. Further, the total happiness (utility) generated by consuming a particular good may also vary considerably across individuals. Hence, while cardinal utility provides a theoretical framework, many economists prefer to use the concept of ordinal utility, which involves simply ranking preferences without assigning numerical values.