Monday  May 10, 2021
 AmosWEB means Economics with a Touch of Whimsy!
 RISK POOLING: Combining the uncertainty of individuals into a calculable risk for large groups. For example, you may or may not contract the flu this year. However, if you're thrown in with 99,999 other people, then health-care types who spend their lives measuring the odds of an illness, can predict that 1 percent of the group, or 1,000 people, will get the flu. The uncertainty is that they probably don't know which 1,000 people, they only know the number afflicted. This little bit of information is what makes risk pooling possible. If the cost is \$50 per illness, then an insurance company can insure your 100,000-member group against flu if they collect \$50,000 (\$50 x 1,000 sick people), or 50 cents per person. By agreeing to pay the cost of each sick person in exchange for the 50 cent payments, the insurance company has effectively pooled the risk of the group.

ORDINAL UTILITY:

The notion that utility--the satisfaction of wants and needs achieved through the consumption of goods and services--is measured by a ranking of preferences (first, second, third, etc.) that are only comparable on a relative basis. Ordinal utility does not presume that satisfaction is a measurable characteristic of a person, like height or weight, that can be compared against an established benchmark. The contrasting notion is cardinal utility, which is based on a numerical standard.
Ordinal utility is a view of utility measurement based on the presumption that the satisfaction of wants and needs is not a quantifiable characteristic of human activity and that preferences are subjective. Preferences among goods can be ranked (first, second, third, etc.) but not measured according to a scale. In this regard, consumers need only specify whether one good is more or less preferred than another. How much more or less a good is preferred is not important.

The ordinal ranking of preferences provides a solid theoretical basis for the analysis of market demand and the law of demand using modern indifference curve analysis.

First by a Nose

Ordinal utility relies on a ranking of preferences. That is, a consumer notes that one good is preferred to another, which is then preferred to a third good. To see how this might work for preferences, consider the type of ranking this is common in sporting events, political elections, and other comparable contests.

The winning team in a baseball game, for example, is the one scoring more runs than the other. It matters not how many more runs the winner scores. It could be one run or one hundred. The winner of a political election is the one that garners more votes than the other. It could be one vote or one million.

To illustrate the nature of ordinal ranking suppose that three people of differing athletic abilities--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.

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

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

• Or lastly, it just might be 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.

Preference Ranking

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.

In particular, the decision by a consumer to purchase one good or another depends on which good is preferred more (assuming equal prices). It could be preferred a little more or lot. It matters not how much more one good is preferred over the other.

Does Paula like hot fudge sundaes 5 percent more than she likes zucchini? It matters not. It only matters that she likes hot fudge sundaes more than zucchini. If so, then she buys hot fudge sundaes, if not she buys zucchini.

Substantially Subjective

The primary reason that modern consumer demand theory relies on ordinal utility is that satisfaction is subjective. In the same way that "beauty is in the eye of the beholder" satisfaction is in the eye of the consumer. The satisfaction that Pollyanna Pumpernickel receives from eating a hot fudge sundae depends on her personal preferences, which are likely influenced by political affiliation, religious belief, cultural background, and a host of other factors.

Such subjectivity is likely to differ from person to person and for the same person from time to time. Does Paula receive more or less satisfaction that Barton Broadway from eating a hot fudge sundae? Does Paula receive more or less satisfaction today than yesterday from eating a hot fudge sundae? Does Paula receive more or less satisfaction from eating a hot fudge sundae than from eating a zucchini? Yes or no or maybe. No one knows.

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Recommended Citation:

ORDINAL UTILITY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2021. [Accessed: May 10, 2021].

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