Utility
- This article is about "utility" in economics and in game theory. For utility companies and similar concepts, see public utility. For utilities in computers, see computer software.
The concept is applied by economists in such topics as the indifference curve, which measures the combination of a basket of commodities that an individual or a community requests at a given level(s) of satisfaction. The concept is also used in utility functions, social welfare functions, Pareto maximization, Edgeworth boxes and contract curves. It is a central concept of welfare economics.
The doctrine of utilitarianism saw the maximisation of utility as a moral criterion for the organisation of society. According to utilitarians, such as Jeremy Bentham (1748-1832) and John Stuart Mill (1806-1876), society should aim to maximise the total utility of individuals, aiming for 'the greatest happiness for the greatest number'.
Utility theory assumes that humankind is rational. That is, people maximize their utility wherever possible. For instance, one would request more of a good if it is available and if one has the ability to acquire that amount, if this is the rational thing to do in the circumstances.
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2 Utility in game theory 3 See also 4 References and additional reading |
Cardinal and ordinal utility
For this reason, neoclassical economics abandoned utility as a foundation for the analysis of economic behaviour, in favour of an analysis based upon preferences. This led to the development of tools such as indifference curves to explain economic behaviour.
In this analysis, an individual is observed to prefer one choice to another. Preferences can be ordered from most satisfing to least satisfing. Only the ordering is important: the magnitude of the numerical values are not important except in as much as they establish the order. A utility of 100 towards an ice-cream is not twice as desirable as a utility of 50 towards candy. All that can be said is that ice-cream is preferred to candy. There is no attempt to explain why one choice is preferred to another; hence no need for a quantitative concept of utility.
It is nonetheless possible, given a set of preferences which satisfy certain criteria of reasonableness, to find a utility function that will explain these preferences. Such a utility function takes on higher values for choices that the individual prefers. Utility functions are a useful and widely used tool in modern economics.
A utility function to describe an individual's set of preferences clearly is not unique. If the value of the utility function were to be, eg, doubled, squared, or subjected to any other strictly monotonically increasing function, it would still describe the same preferences. With this approach to utility, known as ordinal utility it is not possible to compare utility between individuals, or find the total utility for society as the Utilitarians hoped to do.
Utility in game theory
In game theory utility is represented as a function representing the anticipated payoff of each player corresponding to their selected strategy. The domain of any utility function is defined below.
- Consider a system ζ of entities u, υ, ω
- αu + (1 - α)υ
and the probability of υ is (1 - α)(υ).
The correspondence of utility and preference is denoted by:
- u → α = V(u)
The following axioms are required:
- 1) u > υ implies V(u) > V(υ) and is a complete ordering of ζ
- 2) u and υ can exist only in three mutually exclusive orderings:
- u > υ; u < υ; u = υ;
- and all ζ are fully transitive of order
- 3) u > υ implies that u > αu + (1 - α)υ
- 4) u > υ > ω implies that their exists an α such that
- αu + (1 - α)υ > ω
- therefore α(ζ) is continuous
- 5) entities in ζ can be combined algebraically such that
- αu + (1 - α)υ = (1 - α)υ + αu
- and
- α(βu + (1 - β)υ) + (1 - α)υ = γu + (1 - γ)υ
- where γ = α(β)
See also
- microeconomics
- expectation utilities
- list of economics topics
- game theory
- efficient market theory
- risk aversion
- risk premium
References and additional reading
- Neumann, John von and Morgenstern, Oskar Theory of Games and Economic Behavior. Princeton, NJ. Princeton University Press. 1944 sec.ed. 1947
- Nash Jr., John F. The Bargaining Problem. Econometrica 18:155 1950