Utility Maximization Rule & Examples - Study.com

Utility maximization means making economic decisions that guarantee the highest level of consumer satisfaction (benefit). An example is when a ... forTeachers forSchools forWorkingScholars® forCollegeCredit LogIn SignUp Menu Plans Plans Courses Courses AcademicCourses BusinessCourses EnglishCourses HistoryCourses HumanitiesCourses MathCourses PsychologyCourses ScienceCourses SocialScienceCourses SpanishCourses AllCourses CollegeandProfessionalCourses CollegeCredit TransferCredit ProfessionalDevelopment Exploreover 4,600 videocourses BrowseAllCourses AcademicCourses CollegeandProfessionalCourses ByGrade ByGrade ElementarySchoolCourses MiddleSchoolCourses HighSchoolCourses CollegeCourses TransferCreditsCourses GraduateandPost-GradCourses AdultEducationCourses TestPrep TestPrep TeacherCertification TeacherCertification CollegeCreditandGraduateTests CollegeCreditandGraduateTests Nursing Nursing RealEstate RealEstate AllTestPreparationCourses PRAXIS TExES CSET/CBEST FTCE GACE AllTeacherCertificationTestPrepCourses CLEP DSST AP GRE HESI TEAS NCLEX RealEstateLicenses RealEstateSales RealEstateBrokers RealEstateAppraisal Teach Teach TeachingResourcesandCurriculum StateStandardSkills LessonPlans TeacherCertification TeacherProfessionalDevelopment Tutoring Tutoring MathTutoring MathTutoring ScienceTutoring ScienceTutoring BusinessTutoring BusinessTutoring HumanitiesTutoring HumanitiesTutoring AlgebraTutoring CalculusTutoring GeometryTutoring Pre-calculusTutoring StatisticsTutoring TrigonometryTutoring AllMathTutoring BiologyTutoring ChemistryTutoring PhysicsTutoring AllScienceTutoring AccountingTutoring EconomicsTutoring FinanceTutoring AllBusinessTutoring HistoryTutoring LiteratureTutoring WritingTutoring AllHumanitiesTutoring SignUp AcademicCourses BusinessCourses EnglishCourses HistoryCourses HumanitiesCourses MathCourses PsychologyCourses ScienceCourses SocialScienceCourses SpanishCourses AllCourses CollegeandProfessionalCourses CollegeCredit TransferCredit ProfessionalDevelopment TeacherCertification PRAXIS TExES CSET/CBEST FTCE GACE AllTeacherCertificationTestPrepCourses CollegeReadiness CLEP DSST AP GRE Nursing HESI TEAS NCLEX RealEstate RealEstateLicenses RealEstateSales RealEstateBrokers RealEstateAppraisal MathTutoring AlgebraTutoring CalculusTutoring GeometryTutoring Pre-calculusTutoring StatisticsTutoring TrigonometryTutoring AllMathTutoring ScienceTutoring BiologyTutoring ChemistryTutoring PhysicsTutoring AllScienceTutoring BusinessTutoring AccountingTutoring EconomicsTutoring FinanceTutoring AllBusinessTutoring HumanitiesTutoring HistoryTutoring LiteratureTutoring WritingTutoring AllHumanitiesTutoring PeterWashington,KevinNewton Author PeterWashington Instructor KevinNewton Kevinhaseditedencyclopedias,taughthistory,andhasanMAinIslamiclaw/finance.Hehassincefoundedhisownfinancialadvicefirm,NewtonAnalytical. Viewbio Learnaboututilitymaximization.Discovervarioustypesofutility,examineutilitymaximizingrules,andstudyexamplesofmaximizingutilitiesineconomics. Updated:07/26/2022 TableofContentsWhatDoesItMeantoMaximizeUtility?ImportanceofUtilityMaximizationUtilityMaximizingRulesMaximizingUtilityEconomicsExamplesLessonSummaryShow Createanaccount WhatDoesItMeantoMaximizeUtility?Utilityisaneconomicconceptdenotingconsumers'benefitorsatisfactionfromgoodsorservices.Accordingtoeconomictheoriesonrationalchoice,consumersalwaysseektomaximizetheirutility.Itisimportanttounderstandwhatmaximumutilityisbecauseitinfluencesthepriceanddemandofcommoditiesandservices.Utilityistheextenttowhichaneconomicgoodorservicesatisfiestheconsumer'sneeds.Inotherwords,economicutilityistheusefulnessoftheproductorservice.Itispracticallyimpossibletoquantifyaconsumer'sutilityorbenefitineconomics.Analystsindirectlyestimateproductorserviceutilityusingspecificeconomicmodels.DanielBernoulli,aSwissmathematician,firstintroducedtheconceptofutilityinthe18thcentury.Sincethen,economictheorieshaveadvanced,resultingindifferenttypesofutility.Thetwomaintypesofeconomicutilityare: Totalutility—Theaggregatelevelofsatisfactionconsumersderivefromconsumingaparticularcommodity.Totalutilityallowseconomicanalyststodeterminethedemandforgoodsandservices. Marginalutility(MU)—Theadditionalbenefit(fulfillmentandsatisfaction)customersaccruefrompurchasinganextraunitofacommodityorservice.Theconceptofdiminishingmarginalutilityimpliesthatthebenefitsconsumersderivefromanygoodorcommodityareinverselyrelatedtothenumberofunitspurchased.Essentially,themarginalutilityofaproduct/servicedecreasesasthebuyeracquiresadditionalunits. JohnStuartMillandJeremyBenthamappliedtheconceptofutilityinnormativeethics.TheEnglishphilosophersdevelopedtheclassicalideaofutilitarianism,whichjudgesthemoralityofactionsdependingontheirbenefittopeople.Theybelievedthatsocietyshouldalwaysseektomaximizebenefit.Classicaleconomicsassumesthatthebehaviorofconsumersdependsontheavailabilityofresourcesrequiredtosatisfytheirneeds.Assuch,consumersmakerationaldecisionswhenbuyinggoodsorservices. Anerroroccurredtryingtoloadthisvideo. Tryrefreshingthepage,orcontactcustomersupport. YoumustcCreateanaccounttocontinue watching Registertoviewthislesson Areyouastudentorateacher? Iamastudent Iamateacher CreateYourAccountToContinueWatching Asamember,you'llalsogetunlimitedaccesstoover84,000 lessonsinmath,English,science,history,andmore.Plus,getpracticetests,quizzes,andpersonalizedcoachingtohelpyou succeed. Getunlimitedaccesstoover84,000lessons. Tryitnow Itonlytakesafewminutestosetupandyoucancancelanytime. Alreadyregistered?Loginherefor access  Back Resourcescreatedbyteachersforteachers Over30,000videolessons &teachingresources‐all inoneplace. Videolessons Quizzes&Worksheets ClassroomIntegration LessonPlans IwoulddefinitelyrecommendStudy.comtomycolleagues.It’slikeateacherwavedamagicwandanddidtheworkforme.Ifeellikeit’salifeline. JenniferB. Teacher Tryitnow Back Comingupnext: UnderstandingtheIndividualDemandCurve You'reonaroll.Keepupthegoodwork! TakeQuiz Watch NextLesson  Replay Justcheckingin.Areyoustillwatching? Yes!Keepplaying. Yournextlessonwillplayin 10seconds 0:02UtilityforConsumers 0:37WhyDoConsumersCare? 2:17ImpactifIgnored 3:55LessonSummary Save Save Save Wanttowatchthisagainlater? LoginorsignuptoaddthislessontoaCustomCourse. LoginorSignup Timeline Autoplay Autoplay Speed Speed 12Kviews Video Quiz Course 12K views ImportanceofUtilityMaximizationWhatistheimportanceofmaximizingutility?Theconceptofutilitymaximizationiskeyinconsumertheorybecauseithelpseconomicexpertsunderstandhowmarketparticipantsallocatetheirresources.Utilitymaximizationmodelsassumethatconsumersarerationaldecision-makersseekingthehighestlevelofbenefitfromgoodsorservices.Individualsandorganizationsmakeeconomicdecisionsthatguaranteethehighestdegreeoffulfillment(pleasure,happiness,orsatisfaction).Maximizingutilityisastrategicdecision-makingprocess.Forexample,organizationsneedaneffectivestrategicplanwhenmakingpurchasestoguaranteemaximumbenefitdespitelimitedresources.Classicaleconomistsclarifythatbuyersarewillingtopayapricethatalignswiththemaximumutilitytheyexpecttoreceive.Consumersdevelopconsumptionbehaviorsbycomparingthemarginalutility(MU)ofavailableoptionsanddeterminingthecombinationofcommoditiesorservicesthatguaranteemaximumbenefit.Utilitymaximizationisimportantbecauseitallowsconsumers(individualsororganizations)tosatisfytheirneedswithinbudgetlimitations.Thismeansthattheconsumerwantstoachievethehighestmarginalutilitywhilespendingless.Forexample,if"productB"promisesmoremarginalutilityperdollarthan"productA,"arationalconsumerwillpurchasemoreof"productB."Anotherimportanceofutilitymaximizationisavoidingsunkcosts.Economicsandfinanceexpertsdefinesunkcostsaslostinvestmentsthatcannotberecuperatedbecausetheyhavealreadybeenincurred.Examplesinclude: Salariesandbenefits Marketingandresearch Facilityexpenses Installationofnewequipmentorsoftware Economistsagreethatsunkcostsincurnoutilityandcannotberecovered,hencethephrase,"donotcryoverspilledmilk."Assuch,thesecostsarenotconsideredwhenmakingconsumption,investment,orothereconomicdecisions.UtilityMaximizingRulesMUiscalculatedbydividingtotalutilitychangebythechangeinthenumberofunits.Hence:MarginalUtility={eq}\rm\frac{Change\:in\:Total\:Utility}{Change\:in\:Units}{/eq}Totalutilityiscalculatedbyfindingthesumofallutilitiesderivedfromeachconsumptionunit.Itisimportanttoemphasizethatutilitycanchangeinvariouscircumstancesdependingonseveralfactors.Factorstoconsiderwhencalculatingutilityinclude: Budgetconstraints—Theseconstraintsdeterminetheopportunitysetboundary,thatis,allpossiblecombinationsofgoodsandservicesthataconsumercanaffordgiventhepriceandincome. Walras'Law—Thiseconomictheorystipulatesthatifonemarketorproductexperiencesexcesssupply,itmustbebalancedoutbyexcessdemandinanothermarketorproduct. LimitationsofUtilityMaximizationDespitetheimportanceofmaximizingutility,therearenotablelimitations.Thefollowingarethelimitationsofutilitymaximization: Irrationalbehavior—Classicaleconomicsassumesthatconsumersarerationaldecision-makerswhowanttomaximizeutility.However,thisdoesnotalwaysapplyintherealworld.Factorssuchasimpulsivebehaviorandloyaltytospecificproductsorsellersaffectconsumerbehavior. Ordinalutility—Thelawofordinalutilitystatesthatwhileconsumerscannotprovideadefinitevalueforutility,theyunderstandtheirpreferences.Forexample,someconsumerspreferbananastoapples.Thistheoryoffersaroughguidetoconsumerutilityratherthanaspecificmeasureofmaximumbenefit. Boundedrationality—Peoplesometimesmakedecisionsthatdonotconformtoeconomicrationality.Insteadoftakingthebestoption,consumersgenerallysettleforsatisfactorychoicesdependingontheirthinkingcapacity,accesstoinformation,andtime.Forthisreason,utilitychangesdependingonthepersonandthecircumstances. MaximizingUtilityEconomicsExamplesAsalreadyclarified,consumersalwaysseektomaximizeutility.Thefollowingaretwoexamplesofmaximizingutility: Supposeaconsumermustchoosebetweentwochocolatebarsthatcost$2.Onechocolatebarishisfavorite,buthewantstotryanewflavor.Thebuyerismorelikelytochoosethenewflavorbecausethisoptionmaximizeshisutility(satisfaction). Afootballfanmaximizesherutilitybypayinganaffordablepricefordecentseatsatafootballgame.Thisoptionguaranteesmoresatisfactioninsteadofover-spendingfordecentseatsatthesamegameorspendinglessatabasketballgame. Intheentertainmentindustry,individualssometimesthrowmoneyintheair,whichmayseemirrationaltomostpeople.However,thisbehaviorisrationalforwealthypeoplebecausetheyderiveutilityfromtheenjoymenttheygaininknowingtheycanaffordtodoso. LessonSummaryIneconomics,utilityreferstothebenefit(satisfaction)consumersaccruefromgoodsorservices.Theconceptofmaximumutilityinfluencesmarketpricesanddemand.Whiletotalutilityistheaggregatelevelofsatisfactionthataconsumerderivesfromconsumingaspecificcommodity,marginalutility(MU)denotestheadditionalbenefitofconsuminganextraunit.Thelawofdiminishingmarginalutilitystatesthatthelevelofbenefit/satisfactiondecreasesasconsumersacquireadditionalunitsofthecommodity.Utilitymaximizationisimportantbecauseithelpsconsumersavoidsunkcost(moneyconsideredlostbecauseitdoesnotgainutilityandcannotberecoveredafterbeingspent).Economistsusethephrase"donotcryoverspilledmilk"toexplainthatsunkcostsarenotconsideredwhenmakingeconomicdecisions.AkeyfactortoconsiderwhencalculatingutilityisWalras'Lawwhichstipulatesthatifonemarketorproductexperiencesexcesssupply,itmustbebalancedoutbyexcessdemandinanothermarketorproduct.Themainlimitationsofutilitymaximizationareirrationalbehaviorandordinalutility(whichstatesthatconsumersrelyonpreferencesasaroughguidetoutilityinsteadofadefinitevalue).Anotherlimitationisboundedrationalitybecauseconsumerssettlefor"satisfactory"insteadof"best"options.Assuch,utilitychangesdependingonthepersonandthecircumstances.Anexampleofutilitymaximizationiswhenafootballfanchoosestopaywhattheycanaffordfordecentseatsatafootballgameinsteadofoverspendingorpayinglesstowatchanothersport.Anotherexampleiswhenwealthymusiciansderiveenjoyment(utility)fromthrowingmoneyintheair. TounlockthislessonyoumustbeaStudy.comMember. Createyouraccount FrequentlyAskedQuestions Whatisutilitymaximizationwithanexample? Utilitymaximizationmeansmakingeconomicdecisionsthatguaranteethehighestlevelofconsumersatisfaction(benefit).Anexampleiswhenaconsumerdecidestopurchasemoreof"ProductA"andlessof"ProductB"becausethiscombinationguaranteesmorebenefit(utility)perdollar. Howdoesonemaximizeutilityineconomics? Consumersmaximizeutilitybydeterminingthecombinationofgoodsandservicesthatguaranteemaximumbenefit.Forexample,if"ProductB"promisesmoremarginalutilityperdollarthan"ProductA,"arationalconsumerwillpurchasemoreof"ProductB." Registertoviewthislesson Areyouastudentorateacher? Iamastudent Iamateacher UnlockYourEducation Seeforyourselfwhy30millionpeopleuseStudy.com BecomeaStudy.commemberandstartlearningnow. BecomeaMember Alreadyamember?LogIn  Back Resourcescreatedbyteachersforteachers Over30,000videolessons &teachingresources‐all inoneplace. Videolessons Quizzes&Worksheets ClassroomIntegration LessonPlans IwoulddefinitelyrecommendStudy.comtomycolleagues.It’slikeateacherwavedamagicwandanddidtheworkforme.Ifeellikeit’salifeline. JenniferB. Teacher Tryitnow Back Createanaccount UtilityMaximizationRule&Examples|BudgetConstraints&ConsumerChoice Starttoday.Tryitnow Economics101:PrinciplesofMicroeconomics 11chapters| 133lessons |18 flashcardsets {{courseNav.course.topics.length}}chapters| {{courseNav.course.mDynamicIntFields.lessonCount}}lessons |{{course.flashcardSetCount}} flashcardset{{course.flashcardSetCoun>1?'s':''}} Ch1. IntroductiontoMicroeconomics Goto IntroductiontoMicroeconomics Ch2. SupplyandDemandin... Goto SupplyandDemandinMicroeconomics Ch3. ConsumerBehavior&Microeconomics WhoIstheConsumerinMicroeconomics? 3:31 UtilityMaximization:BudgetConstraints&ConsumerChoice 4:56 5:10 NextLesson UnderstandingtheIndividualDemandCurve FactorsthatAffecttheMarketDemandCurve 5:37 Calculating&UsingtheMarketDemandCurveinMicroeconomics 5:01 Substitution&IncomeEffects:ImpactsonSupply&Demand 4:53 Normal&InferiorGoodsinMicroeconomics 3:44 HowtheEngelCurveInfluencesIndividualDemand 5:02 ConsumerPreferences&ChoiceinEconomics 5:12 ConsumerTheoriesinEconomics:DecisionMaking,Incentives&Preferences 5:21 BudgetLines&theRateofTransformationinEconomics 4:39 IndifferenceCurves:Use&ImpactinEconomics 5:21 MarginalRateofSubstitution:Definition,Formula&Examples 5:00 TheIndifferenceCurveforSubstitutes&ComplementsinEconomics 5:01 EconomicsAssumptionsabouttheMaximizationofUtility 5:02 Goto ConsumerBehavior&Microeconomics Ch4. ProducersinMicroeconomics Goto ProducersinMicroeconomics Ch5. BusinessStructures&Barriersto... Goto BusinessStructures&BarrierstoEntry Ch6. Accounting&EconomicCosts Goto Accounting&EconomicCosts Ch7. MarketStructuresinEconomics Goto MarketStructuresinEconomics Ch8. ScarceEconomicResourceMarkets Goto ScarceEconomicResourceMarkets Ch9. BusinessTechnology,Research&... Goto BusinessTechnology,Research&Development Ch10. GovernmentIssuesin... Goto GovernmentIssuesinMicroeconomics Ch11. StudyingforEconomics101 Goto StudyingforEconomics101 UtilityMaximizationRule&Examples|BudgetConstraints&ConsumerChoiceRelatedStudyMaterials RecommendedLessonsandCoursesforYou RelatedLessons RelatedCourses RelatedLessons DiminishingMarginalUtilityPrinciple&Examples|WhatisDiminishingMarginalUtility? MarketFailureCauses&Examples|WhatisMarketFailure? ConsumerPreferenceConcept&Assumptions|WhatisConsumerPreference? TheLawoftheDownwardSlopingDemandCurve Diamond-WaterParadoxOverview&Examples|WhatisParadoxofValue? 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