No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Two: Fundamentals of Economic Behavior 42 UTILITY It’s easy to think about the benefits people receive from one slice of pizza, as compared to four slices of pizza. We know we get more benefit from four slices than from one slice, because we assume that more is preferred to less. But it gets more difficult when we want to think about how individuals value multiple goods. If I go to Wendy’s and only have $3, what do I buy? How do I compare french fries to hamburgers? Economists answer that with the concept of utility , rejecting terms such as satisfaction or happiness. We use the term utility to be the “catch all” for the benefits we receive from anything. So consumers can subjectively assess the utility of a hamburger against the utility of a large coke. Whichever provides a higher utility for a given cost will be chosen. There are several concepts to think about with respect to utility. First, utility is an ordinal concept, not cardinal . This means that an individual can rank hamburgers as more preferred to coke (an ordinal comparison), but can’t say that a hamburger is worth four “utils” while a coke is only two “utils” in making a choice (a cardinal, or numerical comparison). Second, these measurements of utility are subjectively (internally) assessed; that is, they are mentally assessed internally to the chooser, so they cannot be objectively measured. This means that there is no way for someone else to figure out your utility gain from the gift of an ice cream cone; one can only imagine how he or she might feel in that situation, and then think you feel somewhat similarly. This has a further implication that is very important for public policy discussion: there is no way to maximize social utility. We can’t simply add up everyone’s utility (either positive or negative) from a given public policy choice, since utility is an ordinal measurement. While economists often go to elaborate lengths to try and do it anyway (through welfare economics and social welfare functions), they have never overcome the argument by the famous economist Lionel Robbins that it is impossible to make interpersonal utility comparisons. (Interestingly, when confronted with the implications of his analysis that economists couldn’t really say much about public policy choices without making such interpersonal comparisons of utility, Robbins rejected his earlier (1932) work. He did not, however, show why his earlier work was incorrect! But he still supports it here. ) This means that we cannot objectively say a given policy proposal is preferred to another; we can only make subjective preference choices. Of course, as we discussed before, individuals make decisions on the margin—the unit of choice. So we are not really concerned with total utility, but rather marginal utility. Will my utility be higher by eating lunch at Wendy’s or skipping lunch and downloading music off iTunes (and having a big dinner free at home)? As before, we know the marginal utility from each activity decreases the more we partake of it, because we always satisfy our ordinal utility: utility can be rank-ordered; i.e., an individual can say I prefer item A to item B cardinal utility: utility could have an actual numerical measurement if this were true utility: the economic term to assess well-being, happiness or personal benefit; this conceptual idea is subjective and not measurable numerically We know the marginal utility from each activity decreases the more we partake of it, because we always satisfy our most urgent wants first.