Utility: A measure of the satisfaction received from some type of economic activity (i.e., consumption of goods and services or the sale of factor services).
Maximizing utility implies economic agents seek to maximize satisfaction. Utility assigns an ordinal number to every choice state. Utility then measures the preference relationship between choice states, and choice states with higher utility are preferred. Therefore, given a set of choices - a utility maximizing economic agent will always choose their most preferred choice, which by definition is the one with the highest utility.
Assume an economic agent has a choice of two goods to consume, X1 and X2, which can be consumed in quantities (n1, n2) subject to some constraints. Each combination of consumption bundles (n1, n2) of (X1,X2) has an implied utility value, which is observable through the actual bundles selected under various conditions.
For instance, assume an economic agent, subject to some constraint set, chooses to consume (10,2), but is just as willing to consume (5, 20). We can observe that the agent is indifferent between the two bundles. Each bundle is equally preferred, the agent derives equal satisfaction, and thus they have the same utility value. We can also observe that in order to give up the consumption of 5 of X1 they needed to be compensated with 18 of X2. Thus, the marginal rate of substitution of good X2 for X1 between these two states is 5/18, which can also be defined as the price of x1 in terms of x2. |
