What it means
Utility is the economist's word for the benefit or satisfaction a customer gets from something. Total utility adds up the benefit from every unit consumed, so the more of a good a person has, the higher the total utility, at least up to a point.
The extra benefit from each additional unit is called marginal utility, and it usually falls as consumption increases. The first slice of pizza when you are hungry is very satisfying, the second is good, and the fifth adds little, which is known as diminishing marginal utility.
Total utility therefore rises quickly at first and then more slowly. If marginal utility falls to zero, total utility reaches its maximum, and if a person keeps consuming beyond that point, marginal utility can become negative and total utility starts to fall.
Because utility is subjective, it cannot be measured directly. Economists often use willingness to pay in dollars as a practical stand-in, asking how much a customer would pay for the first unit, the second unit and so on.
Businesses use the idea to set prices and design offers. Volume discounts, bundles, free refills and "buy two" deals all reflect the fact that customers value each extra unit less, and a seller who understands this can price in a way that captures more of the total value without pushing customers away.
The concept has limits. It assumes that people are rational and know what they value, and it ignores things such as habit, status and the influence of advertising, so it works best as a way of thinking about decisions rather than as a precise forecast.
In practice
Real-world examples.
Example
A cafe offers a second coffee for half price. Because the customer values the second cup less than the first, the discount encourages extra sales without cutting the price of the first cup.
Example
A software company sells a basic plan, a standard plan and a premium plan. It knows that the extra features in the premium plan are worth a lot to large customers but little to small ones, so it prices accordingly.
Example
A gym offers an unlimited monthly pass rather than pay-per-visit. Members who attend often see high total utility from the pass, while those who go rarely may leave, and the gym plans around the mix.
Formula
Calculation
Total utility = Sum of the marginal utilities of each unit consumed
Using willingness to pay in dollars, suppose a customer would pay $6 for a first coffee in a day, $4 for a second and $2 for a third. Total utility from one coffee = $6, from two coffees = 6 + 4 = $10, and from three coffees = 6 + 4 + 2 = $12. If coffee costs $3, the customer buys two cups, since the third is worth only $2, and total utility minus spending = 10 - (2 x 3) = $4 of surplus.Case study
Seen in the real world.
Brightside Snacks is an illustrative, fictional company that sells chocolate bars for $2 each from vending machines. Market research suggested that a typical customer would pay $2.50 for the first bar and $1.50 for a second, so total utility from two bars was $4.00.
At $2 per bar, most customers bought one, because the second was worth less than its price. Management tested a "two for $3" offer, which was below the $4.00 total utility but above what one bar cost, and customers who would not have bought a second bar at $2 now bought it.
Revenue per transaction rose from $2 to $3 for those customers, and the bars' production cost of $0.60 each left a healthy margin. The illustrative lesson is that understanding how value falls with each extra unit allows a company to design an offer that is attractive to the customer and profitable for the business.
Watch out
Common mistakes.
- Confusing total utility with marginal utility, which is the extra benefit of one more unit and not the combined benefit of all units.
- Assuming that more is always better, when total utility can fall once a person has more than they want.
- Treating utility as an exact number, when it is a way of ranking and reasoning about preferences and not a measurable quantity.
Questions
People also ask.
What is the difference between total utility and consumer surplus?
Total utility is the full value a customer places on the units bought, while consumer surplus is that value minus the price actually paid.
Why does marginal utility fall?
Because each extra unit meets a need that is already partly satisfied, so it adds less than the one before it.
How do businesses use total utility?
They use it to understand willingness to pay, set prices, design bundles and decide when extra units, features or discounts add value for customers.
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