Utility (economic)

Utility essentially refers to the welfare of an individual, it is a measure of the level "satisfaction" with a certain good or bundle of goods. The concept of utility is based on the assumption that a "rational individual" will seek to maximize their utility. Utility measures how satisfied one is, it is comprised of an endless number of factors; some which cannot necessarily be quantified, such as, a level of enjoyment from an activity. Utility basically measures one's preferences.

The concept of utility is used to simplify the assumptions made about consumers, because everybody has different preferences and it is impossible to measure how useful a good is to each unique individual. Determining how much utility a good or service yields to a person helps to determine how the demand is affected in a market. Essentially, why a person wants a good or service.

Reliability

Figure 1. Workers restoring electricity after a hurricane in New Orleans, Louisiana.

The concept of utility can be compared to how useful something is, and the reliability of electricity impacts the usability of many services. Reliable electricity provides a consistent ability to heat homes, run hospitals, use the internet, and more. Unreliable electricity causes dramatic drops in utility. For example, a fridge can only provide utility if the electricity powering it is continuous, if not the food will spoil. Individuals derive utility from energy services, and reliability increases the expected utility of consumption.

Utility is affected by risk and uncertainty. The risk of power shortages or price spikes due to geopolitical risks, supply chain disruptions, or extreme weather events cause reduced utility of energy services. Figure 1 shows how a hurricane can close down power lines.

Externalities

Pollution is an externality that results in negative utility. Air pollution, greenhouse gases, and water contamination create negative utility: health impacts, agricultural productivity, property damage, and generally environmental change. These harmful side effects are negative externalities that reduce social utility, known as the Social Cost of Carbon (SCC). For example, while cheap coal power grants lower electricity bills (positive utility), it also worsens health and lowers quality of life (negative utility).

Cost

The consumer's choice depends on what they can afford, known as a budget constraint. Money that an individual spends on one good is not available for other goods and services. This means that spending more money on your electricity bill results in less available money for everything else, effectively reducing the purchasing power of the consumer. This forces the individual to decide on tradeoffs (reallocating their spending). As an example, rising household energy prices may force consumers to either reduce other essential spending or live at uncomfortable temperatures. The utility of a good/service may be indirectly affected by its cost, because it may impact the ability to buy other essentials.

Marginal Utility

This refers to the additional utility brought by the consumption of one additional unit of a good or service. This is particularly important when examining the behavior and preferences of a consumer. Generally, the more a good is consumed, the less utility it yields. This effect is known as diminishing marginal utility.

Figure 2 features a graph with two patterns. Total utility: shows how total satisfaction increases with additional units, but slows down and eventually reaches a maximum. Marginal utility: represents the extra satisfaction gained from each additional unit, which is a clear downward trend as each additional unit yields less satisfaction.

Figure 2. Comparing total utility and marginal utility.

An example of diminishing marginal utility would be, if a single person buys a car. Buying a car allows the individual to get around the city quickly and efficiently, saving them time. If that same person buys a second car of a similar model, it has less utility or usefulness to that person. The second car is less useful because they can only drive one car at a time, therefore the second car doesn't give them the same amount of utility as the initial car did.

For Further Reading

• Demand
• Market
• Extreme weather events
• Air pollution
• Negative externality
• Pareto Principles
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