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In economics, utility is a measure of a certain person's satisfaction from a certain state of the world. Over time, the term has been used with at least two meanings. In a normative context, utility refers to a goal or objective that we wish to maximize, i.e., an objective function.
A single-attribute utility function maps the amount of money a person has (or gains), to a number representing the subjective satisfaction he derives from it. The motivation to define a utility function comes from the St. Petersburg paradox: the observation that people are not willing to pay much for a lottery, even if its expected monetary gain is infinite.
Cardinal utility appears to impose the assumption that levels of absolute satisfaction exist, so magnitudes of increments to satisfaction can be compared across different situations. However, economists in the 1940s proved that under mild conditions, ordinal utilities imply cardinal utilities.
Standard utility functions represent ordinal preferences. The expected utility hypothesis imposes limitations on the utility function and makes utility cardinal (though still not comparable across individuals). Although the expected utility hypothesis is standard in economic modelling, it has been found to be violated in psychological experiments.
In the context of cardinal utility, liberal economists postulate a law of diminishing marginal utility. This law states that the first unit of consumption of a good or service yields more satisfaction or utility than the subsequent units, and there is a continuing reduction in satisfaction or utility for greater amounts.
Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society. [ 1 ] The principles of welfare economics are often used to inform public economics , which focuses on the ways in which government intervention can improve social welfare .
The notion of social utility is analogous to the notion of a utility function in consumer choice. However, a social welfare function is different in that it is a mapping of individual utility functions onto a single output, in a way that accounts for the judgments of everyone in a society.
In economics, exponential discounting is a specific form of the discount function, used in the analysis of choice over time (with or without uncertainty).Formally, exponential discounting occurs when total utility is given by