Econ 101: Utility — It’s Personal, It’s Complicated, and It Depends

Utility is a 19th century microeconomic concept used to measure consumer satisfaction.  Satisfaction is personal and subjective; it cannot be measured directly.  Utility measures it indirectly by asking consumers to assign numbers to different levels of satisfaction they believe they would experience if they consumed a product or service.  The reason economists bother with a concept like Utility is because it gives them numeric data corresponding to individuals’ needs/wants for a good or service.  Economists lack Audiologists’ linguistic flair, so Utility is measured in the unfortunately-named util, which sort of rhymes with decibel but isn’t as lyrical.

If that sounds weird, just think of all those hearing aid manufacturers’ surveys you’ve filled out, where you assigned a number to the importance of different aspects of service and product.  The higher the number, the higher the Utility, the more utils.  The manufacturers get surveys from a bunch of audiologists, crunch our utils, and use the data to come up with the products and services we need and want.  They are using our Utility responses to determine our Demand and adjust their Supply.  

As you’d expect, desirable goods have higher Utility, meaning that increasing consumption of such good adds up to more utils, at least up to a leveling off point.  That point of “diminishing utility” is usually illustrated in Economics 200 with a box of donuts:  some healthy bro volunteers to eat a box of donuts in front of the class, assigning utils to each one as he finishes it off.  The more donuts he eats, the less he desires the next one and the lower the utils assigned to it.  This goes on till he is begging not to have to eat one more donut.{{2}}[[2]]Like any good scientific concept, Utility has a number of other characteristics that this post won’t go into, but none are as exciting as the donut illustration of diminishing utility with increased consumption.[[2]]

Utility is multifaceted like snowflakes or the dodecahedron pictured above  — few if any people have the same utils per good because individual’s needs/wants for a good or service differ depending on what else they need/want.   In other words, the same thing has different Utility to different people and it depends on the context as well.  This is demonstrated usefully by a recent Stanford-based psychology experiment showing that expensive gifts have more Utility to givers than receivers. Recipients get more Utility from receiving lesser amounts of cash than they do from getting expensive gifts they don’t much want.  Finally, Utility provides us with a scientific explanation of re-gifting.

Speaking of expensive, your personal Utility set-up is only as good as your budget allows.  You may want donuts but be unable to afford a whole box.   You may want two hearing aids, but have to starve to buy them.   Just because you want something (high Utility) doesn’t mean you get it (Budget Constraint).  When comparing goods, you’re going to choose the combination that gives you the most Utility.  Think:  which is better — two hearing aids and no donuts or one hearing aid and 1000 donuts?  As economists always say, “It depends.”

How does Utility help us think about hearing healthcare, you ask? There are various “choice-based” valuations methods to measure “Health Utilities.”  for example, the Health Utilities Index Mark 3 (HUI3) measures utils for a “basket” of health measures, including hearing loss.  But only one preliminary study has used HUI3 to assess utility measures of hearing aids.  Within our field, the US experts are Abrams, Chisolm & McArdle, who have made us aware of Health Utility measurement paradigms such as the “Standard Gamble.”  In the UK,  Dr. Quentin Summerfield and colleagues have used the Time Tradeoff technique, using utility measures of cochlear implantation for cost-benefit analyses for government policy making decisions{{3}}[[3]]Summerfield A.Q., Marshall D.H., Barton G.R., Bloor K.E. (2002). Cost-utility scenario analysis of bilateral cochlear implantationArchives of Otolaryngology — Head and Neck Surgery, 128: 1255-62.  They also have some of the rare data available on utility of hearing aids[[3]]{{4}}[[4]]Barton G.R., Bankart J., Davis A.C., Summerfield A.Q. (2004). Comparing utility scores before and after hearing-aid provision: Results according to the EQ-5D, HUI3, and SF-6D. Applied Health Economics and Health Policy, 3: 103-5.[[4]]In that and other paradigms, Utility in utils is expressed in comparison to another option or a “basket”  of all other options.{{5}}[[5]]This is the way economists talk.  You get used to it, just as we are used to the way Audiologists talk.[[5]]

A person with excellent hearing and no communication difficulty sees little Utility (zero utils) to be gained from consuming hearing aids, compared to the Utility s/he receives from consuming other goods.  Conversely, utils for hearing aids are high for a person with significant hearing loss and a long history of success with hearing aids, who feels lost without his hearing aids and is willing to forego most other things before he will give up his hearing aids.  Based on Utility, we can say this:

 Compared to consumption of all other goods, hearing aid utility and consumption will be low for the person with good hearing and high for the person with significant hearing loss.

Duh. We  knew that without utils, but even as the tiny atom is the building block of our physical world, the lowly util is the building block of market Demand Curves.  Here’s how it starts. Economists use tables with oodles of utils to demonstrate the properties of Utility discussed above and figure out consumer choices:

  • Faced with consumption choices, consumers will always choose the combination that gives them maximum Utility, subject to their budget constraints.
  • Utility will always increase at a decreasing rate as people consume more of a product.

Table 1 below hypothetically considers one golfer’s satisfaction from golfing at his club versus getting hearing aids.  His Utility from hearing aids is shown on the bottom of the graph:  he gets zero utility from no hearing aids, utility jumps to 4 utils for a single hearing aid, and he gets 1 more util with two hearing aids (4+1 = 5).  Note that utility from two hearing aids is not twice as much as utility of one hearing aid.  The marginal utility gained from adding the second hearing aid is only 1 util, not 4 as with the first hearing aid.{{6}}[[6]]Audiologists, do not let this statement upset you.  This is an economic consequence of the diminishing rate of utility with consumption, it is not a commentary on the hearing benefit derived from monaural vs binaural fittings.[[6]] His Utility from golf club membership on the vertical axis also illustrates diminishing marginal utility:  he gets 5 utils of satisfaction with that 1st month of golf, but only gains 4 more utils with a second month of membership (5+4 = 9), etc.

Table 1. Utility Table for Hearing Aid and Golf Club Consumption Choices

Now comes the fun part{{3}}[[3]]OK, maybe you don’t agree that this is fun.  I’m embarrassed to admit to being a total nerd — I love this stuff![[3]]:  using the table we can quickly figure out his optimal utility choice by simply totaling utils for each cell.  For instance, if he choices 1 hearing aid and 1 month of golf, his total Utility is 9 utils (4+5 = 9).  He can do better than that.  If he goes for the gold and gets 2 hearing aids and 5 months of golf, his Utility maxes out at 5+ 15 = 20.  That is what he would do if he had no budget constraints.

 

 

Table 2. Maximum Utility Choice for a Budget of $5000

But, he has a budget constraint of $5000.  Table 2  fills in the costs (money, not utils) of his choices when monthly golf club membership and hearing aids both cost  $1000 each.  Oops, his optimal choice of two hearing aids and 5 months of golf costs $7000, which is way over budget.  In fact, all the maroon colored cells are out of his budget range.  Now the task is simply to search the remaining cells in Table 1 to find the one where he maximizes utility within his budget constraint.  In that range, Utility is highest (18 utils, Table 1) for the choice of 1 hearing aid and 4 months of golf.  He will take that choice, even though other choices also cost $5000, because consumers will always maximize their utility.

This introduces the idea that there is a relation between Utility and willingness to pay. Understanding that relationship allows construction of  individual demand curves.  Those will be the subjects next time we do an Econ 101 post.

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About Holly Hosford-Dunn

Holly Hosford-Dunn, PhD, graduated with a BA and MA in Communication Disorders from New Mexico State, completed a PhD in Hearing Sciences at Stanford, and did post-docs at Max Planck Institute (Germany) and Eaton-Peabody Auditory Physiology Lab (Boston). Post-education, she directed the Stanford University Audiology Clinic; developed multi-office private practices in Arizona; authored/edited numerous text books, chapters, journals, and articles; and taught Marketing, Practice Management, Hearing Science, Auditory Electrophysiology, and Amplification in a variety of academic settings.

4 Comments

  1. Thanks for the article, I liked it very much. It was a straightforward introduction to the concept of utility, and how it’s used. Several years back, I attended a talk by Quentin Summerfield. At the time, the national health service in the uk would pay for a 2nd cochlear implant for children, but not for adults because the cost-benefit ratio was deemed too low (not enough ‘qualys’). I think his efforts resulted in them changing their decision. As someone who works with computational models, I was taken aback by how health care decisions, and particularly those of insurers, are sensitive to the modeling construct used, which may differ from one analysis to the next.

    1. Thank YOU for your comment. Yes, economic modeling is all about the coefficients, variables, and that nasty little “error term.” If you read papers in the economic journals, they always seem to run the model umpteen times with different assumptions, so at least they know that decision-making depends on the modeling. We are fortunate to have people like Dr. Summerfield, who understands the economics, involved in the policy-making decisions. It is my hope that writing what little I know about economics–in a site read mainly by hearing professionals and consumers — will spur more interest in economics among audiologists AND encourage studies that collect data needed to construct useful demand curves for our services and products. In the meantime, I am looking forward to taking the dreaded Econometrics class next fall. If I manage to pass it, perhaps I will have a better handle on the modeling process.

  2. I suspect that the “utils” for most audiologists from this would be expressed in the statement from the text “Duh. We knew that without utils,…”. However, I have been reading Christensen’s theories on disruptive innovation and it is all clear to me. At least as clear as I can take until you post Econ 101, part 2.

    1. Yeah, many people including audiologists find little satisfaction in reading Economics. You and I may be the only readers of this section — economics isn’t called the “dismal science” for nothing. Thanks for reading and commenting.

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