Concept Of Utility And How It's Measured

Utility- Well utility can be defined as the satisfaction people derive from consumption or usage of goods or service. It is measured in terms of "Utils".

People like to utilize fully from their resources or we can say people want to think rationally i.e they want to derive most of the benefits as possible,so they want to use their resources fully.

For example- Imagine a person who went to a restaurant and for rs.120 he judges that food A will yield 15 utils and food B will yield 13 utils,then that person realizes that eating food B will be more beneficial and satisfying. So,here the person wants to utilize the resource(which is rs.120) to get their best satisfaction.

But it also depends on certain circumstances,i.e. tastes and preferences differs from person to person and it impacts hugely on decision making and also the income of people also depends.

How to measure Utility?

There are two ways in which utility can be measured. They are- cardinal and ordinal.

Cardinal Utility- The utility in which the satisfaction is measured in terms of numerically. It is a quantitative approach. It's measured in terms of UTILS.

Example- You went to visit Taj Mahal and Qutub Minar,and after visiting you give ratings on the basis of your satisfaction. On a scale of 5,you rate Taj Mahal highly with 4 and Qutub Minar with 3,this is known as cardinal utility.

Ordinal Utility- The utility in which the satisfaction can be measured in terms of ranks. It is a qualitative approach.

Example- As in previous example you gave ratings higher of Taj Mahal so it will be ranked higher than Qutub Minar.

HOW DO WE MEASURE UTILITY?

Before seeing how to measure utility, let us see what does utility actually mean :- The Concept of Utility is the satisfaction people derive from their consumption activities.

 Assumptions :-

·         Tastes and preferences are fixed and given, and play a large role in decision making.

·         People allocate their income to maximise their satisfaction or total utility.

Now to measure utility there are two approaches, they are  :-

1.       CARDINAL UTILITY.

2.       ORDINAL UTILITY.

Let us discuss about each in detail.

CARDINAL UTILITY

Cardinal utility says that we can measure the utility that is derived from a product in quantitative terms. It also specifies about “UTILS”, which according to the cardinal approach, is the units to measure utility. Let us understand with an example.

Suppose if you buy a Xiaomi smartphone you will get 4000 units of satisfaction and on buying an Apple IPhone you will get around 9000 units of satisfaction. This assigning of a quantitative value to a level of satisfaction derived (which is basically a psychological factor) is what is called as CARDINAL APPROACH.

Another example can be the product ratings we find on e-commerce sites, where the level of satisfaction of the user of the product is often measure on a scale of 0-5 or 0-10 and so on. This is also an example of cardinal approach.

There is another group of economist’s that believe that utility cannot be measured in quantitative terms, hence we have what is called as the ORDINAL UTILITY APPROACH. Let us see in detail

 

ORDINAL UTILITY

Even after knowing rating’s, we tend to focus of ranking or ORDINAL UTILITY. Ordinal utility says that we cannot measure utility in perfect quantitative terms. But we can definitely rank them accordingly and say which gives us more satisfaction over the other.

For example, let’s say a person who is very thirsty at the moment and he is provided with a sandwich and a glass of water. It might not be possible to say how much how much satisfaction is derived from each but, he can easily say that which of the two gives him more satisfaction. In this case as he is thirsty, the glass of water will provide him more satisfaction. This approach to measure utility is what is called as ORDINAL “UTILITY APPROACH”.

In real world usage there is no perfect rule as to which is used in every case, but it is a mixture of both cardinal utility and well as ordinal utility.