Utility (Cardinal Versus Ordinal Utility)

A utility function is a formula that assigns a level of utility to each market basket. The utility function u(F,C) = FC tells us that the level of satisfaction obtained from consuming F units of food and C units of clothing is the product of F and C.

A utility function that generates a ranking of market baskets is called an ordinal utility function. However, it does not indicate by how much one is preferred to another. The ordinal utility theory claims that it is only meaningful to ask which option is better than the other, but it is meaningless to ask how much better it is or how good it is.

A utility function that describes by how much one market basket is preferred to another is called a cardinal utility function.

The objective of economists is to understand consumer behaviour. So all that matters is knowing how consumers rank different baskets, and it is difficult to compute the utility of various market baskets . Therefore, we usually work only with ordinal utility functions, and not cardinal utility functions.