Economic utility

How much is worth for you the satisfaction of a need?

Told simply, economic utility is the personal economic value
attributed to the satisfaction of a need.
An alternative term, less normative, is desirability or ophelimity.

The comparison between this individual value and the market price
is supposed to guide economic decision making.

Is the satisfaction worth the price?

A personal notion

Utility is an economic concept that is supposed to be the criterion that
people, like you and me, use to make their economic decisions.
Economists define it as the
personal monetary sous value that a
person gives to a product, service or asset that satisfies a need /
compensates a want.
In simpler words, utility is the personal measure that somebody
gives, consciously or unconsciously, to a satisfaction it can
obtain via an exchange within the economic world.

Even more clearly, to use money as a yardstick to compare
economic
satisfactions, utility is


how much, in hard currencies (*)
a potential satisfaction is worth for a person
.

Utility can refer to goods, services, actions (and jobs), assets, investments,
projects, businesses or whatever else that might offer an economic
interest (*).

(*) Of course, not every human satisfaction can be reduced to an
     
economic / monetary value.

Utility and preferences

Utility takes into account the person's attraction preferences (or needs, as
needs are determined by the person's hierarchy of preferences between
expected satisfactions, even if some basic needs are common to most
people).

Utility, rationality and desirability

The "Economic man" and "Rational choice" theories assume that utility
is what guides the people's economic decisions.


Here three limitations are seen:
  • People's preferences (and self-interest) are not fully conscious
They are also far from stable. Moreover, it is far from 
obvious
to translate those preferences into economic value
They usually do not have a clear / conscious notion of
the value for them
of an economic goods,
and even less of
all the economic goods they are liable to buy or sell.

  • Preferences, and the decisions / actions to satisfy them, 
are or not always rational.
Actually, distortasymm behavioral biases often interfere. They
might bring outcomes that don't match fully,
or even go
against, what is considered utility.
  • The words "utility" and "needs"
have a rational or moral / normative undertone.
Thus, a more general term like "desirability" or, a more
academic  one, "ophelimity" can also be used
to qualify
personal economic value.

Utility, value, costs

In the sense that economic values are estimates of what things could be
worth, utility is a relative / comparative economic personal
value.


This means that it is a number that allows the person to make comparisons
with the utility / value it gives to other things / to other satisfactions.
=>Thus it gives that person a basis to make economic decisions.

The
factors of production (the resources spent as inputs) have
obviously an incidence on costs. but, whatever some economist states,
they do not
determine by themselves the value or the price
of its outputs
, which depends on the comparative satisfactions they
bring.

price Prices are not just production costs to which the sellers add
their profit margins.
Those inputs are obviously a factor, but seen only from the seller's side.

No business will launch a product without some - objective or
subjective- idea of what buyers are ready to pay for it.
This assumption will help decide to make or not the launch, and to
state  a price (adjustable later, taking also into account the existing
of potential competitors).

Utility and price

Utility differs usually from the marketmarket price.
Therefore, comparing its -conscious or unconscious- utility, with the
current price orientates the person's decision to buy or sell.

This can also mean that the market price is the one that reflects a
balance  between the utilities / economic preferences of all sellers
and buyers.


Where things get complicated is that the economic utility theory
considers that people have a precise idea of that number.
But ....precisely, this is ...theoretical.
=> In reality people have often a rather fog fuzzy
       
and instinctive idea of the value they give  to their
        utility.

Also, various
behavioral biases, as said above, in the form of
cognitive flaws / mistakes, emotional distortions and automatic
responses rather often warp their perception of utility.

Utility and risk (financial utility)

In finance, utility takes risk risk into account. People might prefer:
  1. A certainty to keep or get 100 euros cash
  2. Than a 50% chance to obtain 200 euros instead.
They would consider for example that the "expected utility"
of the second offer is for them, 

      * not 200 x .5 = 100,
      * but only 70 euros.

The discount between the fundamental value of a deal and the expected
utility for the player is a measure of its risk aversion.


This supposes that probabilities are known, which is not always the
case: (see
uncertainty

Note : Risk aversion is often completed - or contradicted - by loss
aversion
after we made a losing investment. see prospect theory.

Social utility & ethics

Social utility (sometimes is the economic utility applied not to a person
but to a whole human
group society, or to mankind itself.

When somebody "sacrifices" a personal utility for what it considers the
utility for other people, this is sometimes called the "genetic utility",
a feeling of empathy, togetherness with other human beings.

The problem is who is able to know in an objective way what is good
for other people?

The utmost precautions are needed to define what is "the common good".

Ethics should be based on something more practical and realistic t
han:
  • Political dogma presentation  dependence  compliance,  a tyrannic stuff that
can bring disasters as History has shown

Reference and further readings

More details on those various notions are found in the
Behavioral finance glossary
Notably the
utility article

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M.a.j. / updated
: 09 July 2015

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