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September 18, 2014 

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WILLINGNESS TO PAY: The price or dollar amount that someone is willing to give up or pay to acquire a good or service. Willingness to pay is the source of the demand price of a good. However, unlike demand price, in which buyers are on the spot of actually giving up the payment, willingness to pay does not require an actual payment. This concept is important to benefit-cost analysis, welfare economics, and efficiency criteria, especially Kaldor-Hicks efficiency. A related concept is willingness to accept.

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UTILITY MEASUREMENT:

A quantification of the satisfaction of wants and needs achieved through the consumption of goods and services. In principle, utility measurement can take one of two forms: (1) cardinal, which is based on numerical values (1, 2, 3, etc.) and (2) ordinal which is based on rankings (first, second, third, etc.). While the hypothetical instructional analysis of utility relies on cardinal utility, ordinal utility is a more realistic way to measure satisfaction.
Utility measurement provides a basis for discussing the satisfaction of wants and needs derived from consumption, which then enables an understanding of the role utility plays in market demand. When economists began looking into the influence utility has on price in the 1800s, they presumed that utility was a characteristic, like height and weight, that could be measured in a cardinal manner.

However, as the study of consumer demand theory progressed, economists realized that cardinal utility was both unlikely and unneeded. Ordinal utility, the ranking or preferences, was not only more realistic, it also provided a sufficient theoretical basis for analyzing the connection between utility and market demand.

Cardinal Utility

Cardinal utility is the measurement of satisfaction using numerical values (1, 2, 3, etc.) that are comparable and based on a benchmark or scale. Height and weight are common cardinal measures.
  • Suppose, for example, that Winston Smythe Kennsington III is 72 inches tall and weighs 180 pounds. In contrast, Pollyanna Pumpernickel is 64 inches tall and weighs 100 pounds. Anyone can easily conclude that Winston is taller and heavier than Paula.

    However, these cardinal measures also make it possible to compare how much taller and heavier Winston is than Paula. In fact, Winston is 12.5 percent taller and 80 percent heavier than Paula.


  • Now consider the height and weight of Barton Broadway, a hulking professional athlete, who is 81 3/4 inches tall and weighs 324 pounds. These cardinal measures indicate that Barton is 12.5 percent taller and 80 percent heavier than Winston. The proportional difference between Barton and Winston is exactly the same as that between Winston and Paula.
Herein lies the benefit of cardinal utility. It is (or would be) based on a fixed scale that allows for comparisons among consumers.

Unfortunately such cardinal measurement does not presently exist for utility. The theoretical prospects of generating such a measurement are also slight. Although early economists worked from the presumption that utility could be quantified with a cardinal measure similar that used for height and weight, the subjective nature of utility makes cardinal measurement unlikely.

Utility is inherently subjective. The satisfaction Pollyanna Pumpernickel obtains from eating a hot fudge sundae is based on her own personal wants and needs, her likes and dislikes. There is no way to compare her satisfaction with that received from an identical hot fudge sundae consumed by Winston Smythe Kennsington III or Barton Broadway.

There is no way to measure how much more or less satisfaction each person receives. Does Barton receive 12.5 percent more utility than Winston? Does Winston receive 12.5 percent more than Paula? Who can say?

Moreover, there also is no way to compare the satisfaction Paula receives from a hot fudge sundae versus watching Barton Broadway participate in his professional sporting pursuit. Does Paula receive 80 percent more utility from a hot fudge sundae than from watching Barton? Who can say?

Ordinal Utility

Ordinal utility is the ranking of preferences (first, second, third, etc.) that are only comparable on a relative basis. Sporting events are commonly subject to ordinal measures.

Suppose, for example, Pollyanna Pumpernickel, Winston Smythe Kennsington III, and Barton Broadway engage in a friendly footrace. Being a highly trained, well-conditioned athlete, Barton finishes first. The petite, but tenacious, Paula comes in second. Winston, hobbled by an old knee injury comes in third.

The ranking achieved by these three runners depends only on the order of their finish. It matters not how swiftly each one covers the distance.

  • Suppose that Barton edges out Paula by the slimmest of margins for first place, while Winston finishes well behind.

  • Or alternatively, suppose that Barton finishes well in front, while Paula edges Winston by the slimmest of margins for second place.

  • Or lastly, suppose that each finishes the race at almost the same time, with Barton coming in just ahead of Paula, who is slightly in front of Winston.
The absolute difference between each runner is irrelevant to the order of finish. Barton is awarded the gold medal for first. Paula receives the silver medal for second. And Winston has the bronze medal for third.

Ordinal utility applies this ranking to preferences. In the modern analysis of consumer demand, the actual level of utility generated from the consumption of a good is irrelevant. Only the ranking of preferences is important.

Does Paula like hot fudge sundaes 80 percent more than watching Barton perform athletic activities? It matters not. It only matters that she likes hot fudge sundaes more than Barton's endeavors.

<= UTILITY MAXIMIZATION


Recommended Citation:

UTILITY MEASUREMENT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: September 18, 2014].


Check Out These Related Terms...

     | util | cardinal utility | ordinal utility |


Or For A Little Background...

     | utility | consumer demand theory | utility analysis | total utility | marginal utility | satisfaction | market demand | third rule of subjectivity |


And For Further Study...

     | utilitarianism | marginal utility-price ratio | utility maximization | constrained utility maximization | consumer equilibrium | rule of consumer equilibrium | marginal utility and demand | marginal utility-price ratio | law of diminishing marginal utility | income change, utility analysis | price change, utility analysis | preferences change, utility analysis |


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