The term utility in economics is defined as the satisfaction or fulfillment an individual gets from consuming a certain good or a service. Utility is one of the major subjects used in understanding consumer behavior in economics. Utility of a good is usually expressed as a function of only the amount of that particular good. However, utility cannot be measured quantitatively and therefore it is a subjective concept depending on each individual. Some economists have argued that utility can be measured in utils but this unit of measurement is not quite clear and also it is not recognized universally. People assume the larger the amount of a commodity consumed the more the level of utility received. Since they believe by taking in a larger amount their satisfaction will increase.
However, that may not be the case. Under the utility principle, we have the concept of marginal utility that is the additional utility enjoyed by a person by consuming an extra unit of a good or service. Marginal utility diminishes as the quantity of a commodity consumed increases. In the case of an increase in income of a person, then his or her marginal utility will also decrease. This can be explained by the fact that as income increases the amount of a good consumed by a rational consumer will increase and as it increases the marginal utility decreases. It is therefore easy to see that utility is an abstract concept, as it cannot be clearly measured in the practical world.
This research paper will aim at identifying ways in which to maximize utility. It will focus on the different schools of thought developed to explain the concept of utility and try to find some common ground to guide in understanding how to maximize utility.
In economics, the concept of utility is very important it is defined as the satisfaction a consumer derives from consuming a commodity or a good. The concept of utility is studied under microeconomics in the topic of consumer behavior. It aims at explaining how a rational consumer in an economy will behave taking in consideration the interactions of several factors I the system. Some of the important factors that may be considered are the prices of the goods consumed by a person and his or her level of income.
Utility is a broad topic and the people who developed the concept of utility were Jeremy Bentham, Daniel Bernoulli and Thomas Bayes. According to Bentham, he believed that utility if considered in terms of pleasure or pain could be measured. This implies that utility is a quantitative aspect in the economy. A later group of economists contradicted Bentham’s view and argued that utility should not be based on the level of pleasure or pain but rather should be determined by the self-interests. Utility was considered branch of normative economics later known as welfare economics. Both Thomas Bayes and Daniel Bernoulli explained the utility concept using probability theory.
There are two main schools of thought concerning the topic of utility; the cardinal approach and the ordinal approach. The cardinal approach was the earlier version; economists who questioned the measurability of utility developed the ordinal approach at a later age. They both give different views on how a consumer should quantify the level of utility. It is difficult to measure the utility of an individual since it cannot be quantified. Most economists believed that utility could be determined by individual’s willingness to pay for different quantities of the various goods.
The cardinal utility approach is the work of Daniel Bernoulli during the 18th century. He tried to apply the logarithmic utility functions to determine marginal utility and explain how it diminishes. The cardinal economists believed that utility was quantifiable according to the pleasure or pain an individual experienced by consuming a good. Under the cardinal approach, the economists believed that utility could be measured using numbers like one, two or three. They came up with the idea that utility can be measured in a unit called utils. They also explained that the utility obtained had an effect on the market prices. The main supporters of this school of thought included; Alfred Marshall and Jeremy Bentham.
In the 19th century, a different school of thought on the topic of utility emerged. These were called the neo-classical who explained that utility could not be measured numerically but a better measure would be to rank the satisfaction that a person received from consuming a good. In 1934, John Hicks and Roy Allen put this idea forward and it was identified as the ordinal approach of utility principle. The ordinal approach explains that numbers cannot be used instead the use of ranks was preferable that meant an individual could identify a good that gives a greater level of satisfaction. For example if three goods were consumed A, B and C and by ranking the order was A, B, C then A would be considered to provide more utility that B and by extension greater utility than C.
For this research paper, the central question will be How to maximize utility? This is important as consumers are considered to want to maximize their utility that is they want to get the highest level of utility they can get from a good that they consume.
In this section of the research, the focus will be on the various scholarly works created by the different economists to explain the theory of utility. Some of the well-known economists who contributed to the concept of utility include Jeremy Bentham, Robert Owen, William Stanley Jevons and Alfred Marshall. They all have different views on how utility should be maximized. Here the paper explores each of their works to gain a better understanding and try to get an answer of our central question of how to maximize utility.
Jeremy Bentham was among the economists of the cardinal school of thought concerning utility. He supported Bernoulli’s idea that utility could be measured numerically. He came up with the idea that pain and pleasure could be measured. According to Bentham, there are four ways to measure utility these were; intensity, duration, certainty and propinquity. In his works, Bentham did not give clear method for the calculation of utility but he based his approach on assumptions and provided a long list of things that should be considered in calculating the level of utility including age and education. Bentham in his works suggested that it is possible to make interpersonal comparisons of utility based on the desirability of a commodity. He focused mainly on the equality of income. Utility does not increase as fast as income, for small changes, the two moves proportionately, so we measure pleasures through the prices they command (Bentham). One of the close followers of Bentham was Robert Owen. He is recognized for his mathematical approach to the concept of utility.
Utility theory found Jevons, Menger and Walras pioneer a new approach in the 1870. Jevons disagreed with Bentham’s idea that utility was measurable. William Stanley Jevons tried to create a connection between utility and demand but this was not successful. He focused on the concept of marginal utility that he believed diminishes as more units of a good are consumed. According to Jevons, utility is subjective but it is important in determining the economic values of services and goods. He further explained that marginal utilities of individuals were influenced by the prices they pay for the goods they consume. Jevons argued that in order to maximize utility an economic agent-the consumer would choose some amount of different goods X and Y such that the marginal utility of X is equal to that of Y; MUX=MUY. An equilibrium in the market is reached when the ratios of marginal utility and prices of the goods are equal; MUX/MUY= PX/PY. In his work, Jevons came up with two ideas to enable in analyzing the concept of utility that is the trading body and the law of indifference. In utility theory, Jevons provided only one application that is the parties taking part in an exchange both gain some fulfillment. However, his equation was most suitable in a situation where an individual faces fixed prices.
Alfred Marshall was another scholar who based his work on diminishing marginal utility. Although he belonged to the cardinal economists, he supported Jevons idea of marginal utility. He explained that marginal utility does determine the demand for a commodity. However, contrary to Jevons, he believed that the supply of a good was determined by its costs of production. Marshall ignored the idea that utilities were interdependent and that they could be ranked. He described that in order to measure the utility of all commodities; one had to sum up the individual utilities. He said that marginal utility did not fully explain market prices and economic values. In the long-run, market prices will be equal to the cost of production for most commodities (Marshall)
Most scholars have criticized the works of both Jevons and Marshall and the majority agreeing that Jevons idea of marginal utility is a preferable approach. This is because it explains decision making on the side of producers. A good is produced based on the subjective utility of consumers and this in turn influences the costs of production that are also subjective. The critics say that a subjective approach to marginal utility is more realistic than Alfred Marshall’s objective approach.
Most people in the current times of studying economics prefer to follow the ordinal approach. As it is assumed more realistic as a consumer can be able to expresses his preference among different goods. This is based on an individuals’ preference or ranking of commodities rather than the use of the cardinal approach. This further explains that it is difficult to make interpersonal comparisons of utility.
The different views from the two schools of thought did not define a clear manner in which utility could be maximized. The cardinals argued that utility is measured in numerical terms while the ordinal economists explained that on had to rank their level of utility obtained from the different goods consumed. However, in their theories they mention the use of indifference curves while others explained that relying on the negatively sloped demand curves was best in determining the optimal level of utility. The one thing that most of the economists agreed on was the law of diminishing marginal utility that is an important aspect when answering the question of how to maximize utility. It is therefore important to know that in utility maximization we do not depend on the total utility of a good rather we base it marginal utility.
The most commonly used method is the use of the indifference curves. An indifference curve is a curve that shows the different combinations of two goods that a person consumes and remains at the same level of utility. The slope of an indifference curve is the Marginal rate of substitution. That is the amount of good X that a person is willing to give up in order for him or her to consume an extra unit of good Y. Under this concept, in order to maximize utility a persons’ budget line should be put into consideration. The budget line shows the level of income of an individual and his or her purchasing power for the commodities. In order to maximize utility an individuals’ expenditure on the goods should not exceed their income. This means that the objective function will be to maximize the utility of a consumer subject to the budget line, which acts as the constraint. A rational consumer will want to maximize his or her utility while considering the budget constraint. This will be arrived when there is a tangency at the highest indifference curve that a person can afford considering his budget line.
This can be written as;
OBJECTIVE FUNCTION; Maximize Utility U=f (X, Y)
CONSTRAINT Subject to. P1X + P2Y = M
Where: M is the individual’s income P1 is the price of good X P2 is the price of good Y
MUX / MUY = PX / PY
This equation is similar to that of Jevons in which he considered to arrive at the optimal utility the costs of production incurred by a producer and the utility of a consumer.
In utility maximization unlike the belief of some of the scholars, demand curves are not a method for determining utility maximization. Instead, the demand curves of an individual can be derived by using their indifference curves and the budget constraint by simply changing the price of a commodity.
In summary having reviewed the different schools of thought, and described the thoughts of both the cardinal economists and those of the ordinal economists then it is possible to answer the question of how to maximize utility. The use of indifference curves has been useful in the determination of utility maximization. As explained by Stanley Jevons in determining utility maximization the marginal utilities of the goods consumed and their prices are important factors to consider. In order to maximize utility this paper has established that as the quantity of a good consumed increases then the marginal utilities decrease. It is important to know that in the modern economics most scholars rely on the ordinal approach to utility maximization.
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