Utility Analysis

UNIT II: UTILITY ANALYSISConcept of Utility * For effective decision-making, businessmen have to analyze and understand consumer behavior. Every rational human being endeavors to maximize his total utility by selecting the best from the given set of alternatives. * Utility refers to the satisfaction or pleasure that a consumer obtains by consuming the product or service; or want-satisfying ability of a good or service. * The concept of utility has been developed to explain the basic principles of consumer choice and behavior. Choice is different from preference. When we talk about preference, we only express our likes and dislikes. By contrast, a choice is something that we select from our preferred alternatives that suits our budget well. By utility, we mean the level of satisfaction obtained by consuming a good/ service preferred by a consumer. * Given the limited resources, a rational consumer allocates his money in such a way that the preferred combination of goods/services gives him the highest level of satisfaction. | | | approaches to Measurement of Utility There are two approaches, namely cardinalist approach and ordinalist approach, to estimate utility. According to the cardinalist approach, utility can be measured in subjective units, say 10 utils, 20 utils, 30 utils, etc. Conversely, ordinalists feel that utility cannot be measured, but can only be ranked in order of preference (e.g. 1st, 2nd, and 3rd, etc). Cardinalist Approach Ordinalist Approach | Good Utility (in utils) Rank order | A 14 2nd B 03 5th C 10 3rd D 08 4th E 17 1st | * According to the cardinalist approach, we choose a good