Utility (economics)

In economics, utility is a measure of preferences over some set of goods (including services: something that satisfies human wants); it represents satisfaction experienced by the consumer of a good. The concept is an important underpinning of rational choice theory in economics and game theory: since one cannot directly measure benefit, satisfaction or happiness from a good or service, economists instead have devised ways of representing and measuring utility in terms of measurable economic choices. Economists have attempted to perfect highly abstract methods of comparing utilities by observing and calculating economic choices; in the simplest sense, economists consider utility to be revealed in people's willingness to pay different amounts for different goods.

Utility is usually applied by economists in such constructs as the indifference curve, which plot the combination of commodities that an individual or a society would accept to maintain a given level of satisfaction. Utility and indifference curves are used by economists to understand the underpinnings of demand curves, which are half of the supply and demand analysis that is used to analyze the workings of goods markets.

Individual utility and social utility can be construed as the value of a utility function and a social welfare function respectively. When coupled with production or commodity constraints, under some assumptions these functions can be used to analyze Pareto efficiency, such as illustrated by Edgeworth boxes in contract curves. Such efficiency is a central concept in welfare economics.

In finance, utility is applied to generate an individual's price for an asset called the indifference price. Utility functions are also related to risk measures, with the most common example being the entropic risk measure.

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