Chapter 4: Utility

Background of Utility

• Origin: The concept of utility predates its introduction in economics.
• Philosophical Use: Philosophers and English authors used "utility" to explain the overall well-being and happiness of individuals.
• Numeric Value: Utility began to be quantified numerically, suggesting that higher utility equates to greater happiness.

Defining Utility

• Utility as a Measure: Utility serves as a measure of happiness:
  • More utility = More happiness
  • Less utility = Less happiness
• Units of Measurement:
  • Utility is measured in utils (like kilograms for weight, centimeters for length).

Examples of Utility Measurement

• Individual A: Utility = 10 utils
• Individual B: Utility = 4 utils
• Conclusion: Individual A is happier than Individual B.

Aim of Individuals

• Maximization: The primary aim of individuals is to maximize their utility.

Issues with Utility Measurement

• Quantifying Utility: Difficulty arises in quantifying utility across different choices.
  • Individual A: 1 util = 10 minutes of laughter.
  • Individual B: 1 util = 5 minutes of laughter.
• Case Study: Both individuals watch a 1-hour comedy show:
  • Individual A claims 5 utils.
  • Individual B claims 10 utils.
  • Actual happiness is equal despite different utility claims.

Psychological Nature of Utility

• Classical Utility: Classical economists view utility as psychological, dependent on individual perceptions.
• Preference Description: Economists shifted to viewing utility as a description of preferences rather than quantifiable data.

Cardinal vs. Ordinal Utility

• Cardinal Utility:
  • Utility expressed in numeric terms.
  • Example: Individual prefers Bundle A (1 car, 2 TVs) over Bundle B (2 cars, 0 TVs).
• Ordinal Utility:
  • Focus is on ranking bundles rather than specific utility values.
  • Example: Preferences can be shown without concern for the actual utility number.

Key Differences

• Ranking Importance: The aim is to rank bundles, not to assign specific utility values.
• Magnitude Irrelevance: The gap in utility values does not matter, only the order of preference does.
• Examples:
  • Individual 1: 3 (A) > 2 (B) > 1 (C)
  • Individual 2: 17 (A) > 10 (B) > 0.02 (C)
  • Individual 3: -1 (A) > -2 (B) > -3 (C)
• All demonstrate the same preference order regardless of utility values.

Conclusion

• Utility Assignment: There is no unique way to assign utilities; different numbers can represent the same preferences.
• Final Notes: Only the ranking of bundles matters in the context of utility.