A qualitative idea such as utility can be difficult to measure, but economists try to quantify the concept in two different ways: cardinal utility and ordinal utility. Both are imperfect, but each can provide an important foundation for studying consumer choice.
In economics, utility simply means the satisfaction that a consumer experiences from a product or service. While the concept is considered an important factor in decision-making and product choice, it presents a problem for economists trying to incorporate the concept to microeconomics models because utility varies among consumers for the same product, and it can be influenced by other factors, such as price and the availability of alternatives.
Utility comes in two types: cardinal and marginal.
Cardinal utility assigns a number to the utility, such as a basket of apples gives a utility of 10 and a bushel of corn is 20.
Marginal utility is based on the idea utility functions diminish as quantities of products are increased.
Cardinal utility is an attempt to quantify and abstract concept because it assigns a numerical value to utility. Models that incorporate cardinal utility use the theoretical unit of utility, the util, in the same way that any other measurable quantity is used. For example, a basket of bananas might give a consumer a utility of 10, while a basket of mangoes might give a utility of 20.
The downside to cardinal utility is that there is no fixed scale to work from. The idea of 10 utils is meaningless in and of itself, and the factors that influence the number might vary widely from one consumer to the next. If another consumer gives bananas a util value of 15, it doesn’t necessarily mean that the individual likes bananas 50% than the first consumer. The implication is that there is no way to compare utility between consumers.
One important concept related to cardinal utility is the law of diminishing marginal utility, which states that at a certain point, every extra unit of a good provides less and less utility. While a consumer might assign the first basket of bananas a value of 10 utils, after several baskets, the additional utility of each new basket might decline significantly. The values that are assigned to each additional basket can be used to find the point at which utility is maximized or to estimate a customer’s demand curve.
An alternative way to measure utility is the concept of ordinal utility, which uses rankings instead of values. The benefit of using rankings is that the subjective differences between products and between consumers are eliminated, and all that remains are the ranked preferences. One consumer might like mangoes more than bananas, and another might prefer bananas over mangoes. These are comparable, if subjective preferences.
Lastly, utility is used in the development of indifference curves, which represent the combination of two products that a consumer values equally and independently of price. For example, a consumer might be equally happy with three bananas and one mango or one banana and two mangoes. As a result, three bananas plus one mango and one banana plus two mangoes represent two points on the consumer’s indifference curve.