Utility Theory

First: Cardinal
Second: Ordinal
Third: Cardinal
In Essence the Principle of
Utility has two routes
P r i n c i p l e o f
U t i l i t y

N a t u r a l I Ad re t ni f i t c i t i ya l I d e

A d a m S J me r i et h m y B e n
 Jeremy Bentham

• February 15, 1748-June 6, 1832

• The philosopher and jurist Jeremy Bentham (1748-1832)
was born in Spitalfields, London, on 15 February 1748. He
proved to be something of a child prodigy: while still a
toddler he was discovered sitting at his father's desk
reading a multi-volume history of England, and he began
to study Latin at the age of three. At twelve, he was sent to
Queen's College Oxford, his father, a prosperous attorney,
having decided that Jeremy would follow him into the law,
and feeling quite sure that his brilliant son would one day
be Lord Chancellor of England.
Jeremy Bentham
• Bentham, however, soon became disillusioned with the law,
especially after hearing the lectures of the leading authority of
the day, Sir William Blackstone (1723-80). Instead of practising
the law, he decided to write about it, and he spent his life
criticising the existing law and suggesting ways for its
improvement. His father's death in 1792 left him financially
independent, and for nearly forty years he lived quietly in
Westminster, producing between ten and twenty sheets of
manuscript a day, even when he was in his eighties.
Jeremy Bentham
• Bentham is often credited with being one of the
founders of the University of London, the forerunner
of today's University College London. This is not, in
fact, true. Bentham was eighty years of age when the
new University opened its doors in 1828, and took no
part in the campaign to bring it into being. However,
the myth of his participation has been perpetuated in a
mural by Henry Tonks (1862-1937), in the dome
above the Flaxman gallery in the main UCL library
Jeremy Bentham
• Yet although Bentham played no direct part in the
establishment of UCL, he still deserves to be considered
as its spiritual father. Many of the founders, particularly
James Mill (1773-1836) and Henry Brougham (1778-
1868), held him in high esteem, and their project
embodied many of his ideas on education and society.
Jeremy Bentham
 Jeremy Bentham
• The cabinet contains Bentham's preserved
skeleton, dressed in his own clothes, and
surmounted by a wax head. Bentham
requested that his body be preserved in this
way in his will made shortly before his
death on 6 June 1832. The cabinet was
moved to UCL in 1850.
 Jeremy Bentham
Not surprisingly, this peculiar relic has given rise to numerous
legends and anecdotes. One of the most commonly recounted is
that the Auto-Icon regularly attends meetings of the College
Council, and that it is solemnly wheeled into the Council Room
to take its place among the present-day members. Its presence, it
is claimed, is always recorded in the minutes with the words
Jeremy Bentham - present but not voting. Another version of the
story asserts that the Auto-Icon does vote, but only on occasions
when the votes of the other Council members are equally split.
In these cases the Auto-Icon invariably votes for the motion.
Extract from Jeremy Bentham's Last Will
and Testament

My body I give to my dear friend Doctor Southwood

Smith to be disposed of in a manner hereinafter
mentioned, and I direct ... he will take my body
under his charge and take the requisite and
appropriate measures for the disposal and
preservation of the several parts of my bodily
frame in the manner expressed in the paper
annexed to this my will and at the top of which I
have written Auto Icon.
Extract from Jeremy Bentham's Last Will
and Testament

If it should so happen that my personal friends and

other disciples should be disposed to meet
together on some day or days of the year for the
purpose of commemorating the founder of the
greatest happiness system of morals and
legislation my executor will from time to time
cause to be conveyed to the room in which they
meet the said box or case with the contents therein
to be stationed in such part of the room as to the
assembled company shall seem meet .
Jeremy Bentham
• February 15, 1748-June 6, 1832
• Introduction of Morals and
Legislation (1789)
• “Nature has placed mankind under the
governance of two sovereign masters, pain
and pleasure. It is for them alone to point
out what we ought to do as well as to
determine what we shall do” (p.17)
 Natural Harmony

• Remember that for Adam Smith the “self”

would with the check of the market lead to
“economic progress”
• Bentham did not see Natural Harmony
– Example is that fact that there is CRIME
 Bentham’s Central Point
• Interest of the Individual must be identified with
the general interest, and that it was the business of
the legislatures to bring about this identification
through direct intercession.
• Bentham is similar to the Greek Hedonism
philosophy
• Differs: “The greatest happiness for the greatest
number (of individuals)”
 “Moral Arithmetic”
• Influenced by Newton he not only his work
to scientific but thought that if there was a
possibility of measurement than legislatures
could measure Social Welfare
• Pleasure are added at the individual level
but multiplied by the number of individuals
The Felicific Calculus
• The Intensity of • Its propinquity or
Pleasure or Pain remoteness
• Its duration • Its fecundity, or the
• Its Certainty or chance it has of being
uncertainty followed by sensations
of the same kind
– Pleasure ⇒ Pleasure
– Pain ⇒ Pain
 The Felicific Calculus
• Its purity, or the chance that it has of not being
followed by sensations of the opposite kind
– Pleasure ⇒ Pain
– Pain ⇒ Pleasure
• Its extent, that is, the number of people who are
affected by it
• NOTE: fecundity and purity are not inherent
properties of pleasure or pain, thus, only matter in
the aggregate of an event
Measure of Social Welfare
on a Given ACT
• First for any given one person of those
whose interest seem most immediately to
affected by it: and take account:
– Of the value of each distinguishable pleasure
which appears to be produced in the first
instance
– Of the value of each pain which appears to be
produced by it in the first instance
Measure of Social Welfare
on a Given ACT (cont.)
• Of the value of each pleasure which appears
to be produced by it after the first. This
constitutes the fecundity of the first
pleasure and the impurity of the first pain
• Of the value of each pleasure which appears
to be produced by it after the first. This
constitutes the fecundity of the first pain
and the impurity of the first pleasure
Measure of Social Welfare
on a Given ACT (cont.)
• Sum up all the values of all the pleasures on
the one side, and those of all the pains on
the other. The balance, if it be on the side
of pleasure, will give the good tendency of
the act upon the whole, with respect to the
interests of that individual person; if on the
side of pain, the bad tendency of it upon the
whole.
Measure of Social Welfare
on a Given ACT (cont.)
• Take the people that appear to be concerned
find those that have a pleasure balance and
add up their degrees of pleasure; then take
those that have a pain balance and add up
their degrees of pain. Take a balance and
that yields the social welfare impact
 Finals Remarks on Bentham
• How to compare across individuals
• Problems in weighting: for instance, which
produces higher pleasure (or pain): those of
the mind or the body.
• Fallacy of Composition
– what is true of the parts may not be true of the
whole
Arsine-JulesEmile-Juvenal
Dupuit

1804-1866
Born in Fossano, Italy which at the
time was under French domination
 Jules Dupuit
• Graduated from the School of Civil
Engineering in Paris
• He was one of the great engineers of his time.
• In 1855, he was name Inspector-General of
Civil Engineering
• Took the study of political economy more as
an avocation rather than a profession
 Dupuit’s Approach
• Combined three elements to produce
analytical tools:
– subjects of economic interest and importance
– relevant, observed facts and statistics from
these subjects
– mathematical analysis-deductive logic and
graphical depiction- to organize and reorganize
relations suggested by these facts and statistics.
 Marginal Utility and Demand
• Early work of Gregory King (1648-1712),
which was refined by the work of Charles
Davenant (1656-1714), found the inverse
relationship between price and quantity.
• The work by Davenant is:
– An Essay upon the Probable Method of Making
a People Gainers in the Balance of Trade (1699)
• The King-Davenant law of Demand
 King-Davenant’s Law of
Demand
Defect Above the
Common Rate
1 tenth 3 tenths
2 tenths Raises 8 tenths
3 tenths the 1.6 tenths
4 tenths price 2.8 tenths
5 tenths 4.5 tenths
 Marginal Utility and Demand
(Jules Dupuit)
• Using the example of Water consumed in a
city he argued that if it was difficult to
obtain the water and they had to pay 50
Francs and they purchased it that it had to
provide the household with at least that
much utility
 Dupuit and Marginal Utility
• However, he argued that as more water was
introduced to the city the time would come
when the households would not require
more
• Consequently, the concept of the Law of
Diminishing Mariginal Utility
 Dupuit’s Argument
MU=
Price

p1

p2

q1 q2 Quantity of Water
 Dupuit’s Consumer Surplus
Quantity
Thus, if price is p1 consumer pays
Or1p1 and the consumer surplus is
r1p1P

r1

r2

O p1 p2 p
Price
 Consumers’ Surplus, Monopoly, and Discrimination
Yield of the Toll
Tariff # of Passengers Utility Gross Net :2 f @
0 100 445 0 -200
1 80 425 80 -80
2 63 391 126 0
3 50 352 150 50
4 41 316 164 82
5 33 276 165 99
6 26 234 156 104
7 20 192 140 100
8 14 144 112 84
9 9 99 81 63
10 6 69 60 48
11 3 36 33 27
12 0 0 0 0
 William Stanley Jevons

1835-1882
(drowned just short of 47)
 W. S. Jevons

• Raised in a Unitarian Environment

– (educated but not academic)
• Financial problems led him to move to Australia at the
age of 18
• He wrote a book in which he he made an analogy of
coal to the industrial age much like corn in Malthus’
population theory
 W. S. Jevons
• He also wrote about the business and solar cycles
(The Solar Period and the Price of Corn - 1875)
• Also known for his first attempts at understanding
inflation in “On the Study of Periodic Commercial
Fluctuations”- 1862 and “ A Serious Fall in the
Value of Gold” - 1863
 W. S. Jevons
• Utility and Marginal Analysis
• Jevons noted the work of Weber-Fechner
• Recognized the difficulty of a cardinal
measurement and acknowledge that only an
ordinal measurement could be found
• However, proceeded as if indirectly the
cardinal measurement could be found
 Graphical Analysis
TU

Units of X
MU

Units of X
 Utility
• The Equimarginal Principle
– MuX = MUY

• The only difference with the Equimarginal

Principle is that it assumes the PX = PY= 1
 Theory of Exchange
MU Beef
MU Corn

MU Beef
MU Corn
 Theory of Labor
Pleasure Degree of Utility of Real Wages

Real Wages
or Amount of
Product
Net Pain of Labor Curve

At Arrows have same

Pain amount
 Ordinal Utility
2 U
U

x1

x2
 Expected Utility
• Expected Value
– E(X) = p1O1 + p2O2 + p3O3
– Where p1 + p2 + p3 = 1
• Expected Utility
– U(X) = p1U(O)1 + p2U(O)2 + p3U(O)3
Risk Averse vs. Risk Loving
Total Utility

Risk Neutral

Return on Investment
Risk Averse vs. Risk Loving
Total Utility

Risk Averse

Return on Investment
Risk Averse vs. Risk Loving
Total Utility

Risk Loving

Return on Investment