Utility: How People Really Value Their Purchases

In economics, utility is how satisfied we become from the state of our surroundings. When utility and preference align, that is known as the best alternative — at least the most preferred one. Generally, utility is the measurement at which how much functionality a product or service has to have for us to be satisfied with. It correlates directly to our desires, and can be considered as a combination of our wants (desires) and needs (functions). The better aligned a product or service is with both, the more we are willing to pay the price. When a product mainly serves a need (function), we’ll just look for the cheapest alternative.

It’s a subjective measure that represents the benefit somebody gets from consuming a good, service, or experience. Keyword: subjective. Utility guides decision-making, as you and I seek to maximize — to choose the option with the greatest overall benefit. It’s important to understand because it directly influences how high the demand, and therefore price, of a good or service can be. The higher the utility of your offering, the more you can charge. In other words, the more value you provide, the more money you can ask for.

Utility has many nuances. We love leisure time. But we like leisure time in combination with income more. It also tends to be a diminishing function. As more of a good is consumed, the utility from each extra unit decreases. Think: a pizza. You eat one slice, it’s absolutely delightful. By the third, the bites are getting uncomfortable. Come the twelfth slice — most pizzas are cut into twelve slices, so you’re done, congratulations — and the last chew goes down with regret. That’s what opportunity cost is: the utility forgone by choosing one option over another. We always pick what aligns with our preferences and utility.

Real-life implications of utility:

• Personal Decisions: you want to maximize your overall satisfaction or happiness with limited resources — time, money, and energy. How? Evaluate the benefits and costs of options. Think long-term goals in balance with short-term pleasure.

• Business Strategy: a business aims to optimize resource allocation to maximize value for customers and stakeholders. How? By developing products and services with high utility. A tech company might invest in developing features that enhance user experience, knowing customers derive incredible utility from these improvements and are willing to pay the price.

• Investments: your goal is financial decisions that maximize utility, taking into account both potential gain and loss. How? Calculate the expected utility by weighing potential returns against risks. Diversify to smooth out your losses.

• Governing: the objective is to design policies that enhance the collective welfare of society by maximizing utility. How? They might asses how policies on various segments of the population work by estimating changes of utility, considering trade-offs — healthcare, education programs. For instance, a government could invest in public education reform to improve long-term societal utility.

How to use utility as a mental model: (1) find your preferences — understand your own, your team’s, or your organization’s value systems, to know where trade-offs are acceptable, to know those priorities; (2) quantify benefits — where possible, assign numerical values to the pains and gains of each option, perhaps with a decision tree; (3) travel in time — factor in both immediate and future utility, since some short-term sacrifices result in long-term gains; (4) be a pessimist — include risk in your utility calculations, since worst-case scenarios are part of life, unfortunately.