Utility a very important term used in economics terminology. Let us understand what does this term means. One job for decentralized markets is to facilitate consumers to choose the goods and services that will give them the majority of satisfaction. Instead of "satisfaction" or "pleasure," economists use the term utility. They say that consumers try to maximize utility.
When one goes to an ice cream shop, what is he/she likely to order? One scoop of chocolate cream in a sugar cone? Frozen yogurt ice-cream in a cup? A large sundae?
As an economist, one cannot say which choice you will make. But I'll bet that you never walk up to the counter and say, "Give me twenty gallons of every flavor you've got in your freezer." Why not?
One might say that I do not order all that ice cream because I can’t afford it. That may be true and is also a reasonable answer. But, one might have sufficient money or credit to pay for that much gallons of ice cream. Then also, one would not buy that much. So eating ice cream follows the law of diminishing returns. One cannot spend more than a few dollars at a time for an ice cream, because the additional ice cream is not appeal as much to you as the one scoop or two.
There is a numerical example that we can use to justify the above point, which is really not anything but common sense. Assume that each scoop of ice cream costs two dollar, and that the total utility one can get from the ice cream consumption at a single sitting follows this pattern:
Number of Scoops
(satisfaction, measured in $)
If these figures are given for satisfaction and cost, then what is the optimal number of scoops of ice cream for you to order?
If you see the table and say that the optimal number of scoops of ice cream is 4, then your answer is wrong. It is a very reasonable mistake, but it is very significant to understand why it is wrong.
It is true that $7.80 is the highest satisfaction that you can get from ice cream, because after that you become satisfied and satisfaction goes down after eating more ice cream than this. But optimization means comparing benefits and costs both, and when one takes costs into account, then for 4 scoops of ice cream cost is high.
To maximize consumer surplus, the difference between benefits and costs are calculated. Then with 3 scoops of ice cream, the consumer's surplus is $8.10 - $6.00, or $2.10. So it gives the maximum satisfaction to a consumer.
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