Overview
This lecture explains the concept of utility, its measurement, and its importance in understanding consumer demand and behavior. It contrasts the cardinal and ordinal approaches to measuring utility, highlighting the evolution towards quantifying utility in monetary terms.
Importance of Studying Utility
- Utility explains why consumers demand certain quantities of goods at different prices or incomes.
- Demand theory analyzes consumer behavior, which is driven by utility or satisfaction from consuming products.
- Understanding utility helps connect the theory of demand with consumer purchasing decisions.
Connection Between Utility and Demand
- Demand is defined as a consumer's willingness and ability to pay for a product.
- Changes in prices or incomes affect quantity demanded through changes in perceived utility.
- The demand curve and its laws are derived from the principles of utility.
Methods of Measuring Utility
- Utility is defined as the satisfaction or happiness derived from consuming a product.
- There are two main approaches to measuring utility: cardinal and ordinal.
Cardinal Utility Approach
- Measures utility in quantifiable, numerical terms (e.g., utils or money).
- Utils are imaginary units representing satisfaction (e.g., 1 chocolate = 10 utils).
- Allows direct comparison of satisfaction from different products.
- Alfred Marshall proposed measuring utility in money terms, equating utility to the price paid.
- If a consumer pays $2,000 for a product, they are assumed to derive $2,000 worth of utility.
Ordinal Utility Approach
- Ranks preferences instead of assigning numerical values to satisfaction.
- Focuses on the order of preference (e.g., preferring apples to oranges).
- Forms the basis for indifference curve theory.
- Considered a psychological or mental ranking, not measured by numbers.
Money as a Measure of Utility
- Alfred Marshall's approach links marginal utility to the price paid for a product.
- Utility is considered equal to the monetary amount a consumer is willing to pay.
- This practical approach forms the basis for further discussion of utility in economic theory.
Key Terms & Definitions
- Utility — Satisfaction or happiness from consuming a good or service.
- Demand — Willingness and ability of a consumer to pay for a product.
- Cardinal Utility — Measuring utility using quantifiable numbers (utils or money).
- Ordinal Utility — Ranking satisfaction in order of preference, without quantifying.
- Utils — Imaginary units used to express utility numerically.
- Marginal Utility — Additional utility from consuming one more unit of a good.
- Indifference Curve — Graphical representation of combinations of goods providing equal satisfaction.
- Alfred Marshall — Economist who proposed measuring utility in money terms.
Action Items / Next Steps
- Review the ordinal utility approach and indifference curve theory in upcoming lessons.
- Apply the monetary measurement of utility when analyzing demand and consumer behavior in future problems.