What is utility maximization

What is utility maximization in business administration / economics? - Explanation & example

Definition of benefit maximization

The word consists of the combination of the terms “benefit” and “maximize”. Initially formulated in general terms, it is the principle of decision-making processes, according to which decision-makers, in accordance with their existing budget, aim to ensure that their overall benefit from the various quantities of products is as high as possible. Applied to companies, it means that maximizing profits for their company is the ultimate goal. The striving of companies to maximize profits and the striving of individuals to maximize utility form the perfect market under competitive market conditions.

The term benefit

In economics

The assumption in economics is that households strive to maximize utility. In the private household, according to the rational principle, the household income is to be distributed among services and goods in such a way that the household benefit is maximum and a household optimum can be achieved from this. After a certain level of consumption, saturation occurs. According to Gossen’s laws, the marginal utility is now zero or negative. From this, classical economics draws conclusions with regard to supply and demand, prices, production and consumption. In microeconomics, it is believed that there is utility maximization when the market is in equilibrium.

In business administration

In business administration, the benefit is examined with the help of a cost-benefit analysis. The utility value analysis is a method of decision theory that is particularly useful in investment calculations. The customer benefit is examined on the basis of functional characteristics such as the basic function of a product and economic (efficiency of product use), emotional, process-related (handling of a product) and social benefits. The benefit component is the core of economic theory. Use decisions about goods are always made taking into account their utility value and their utility value.

Benefits are divided into:

  • Benefit: basic benefit + additional benefit
  • Additional benefit: validity benefit + heritable building benefit
  • Building benefit: Creativity + confidence
  • Confidence: harmony + order

The utility function

The utility theory deals with the marginal utility, with the indifference curve, the preference, the external effect and the utility function. With the establishment of a utility function, bundles of goods are assigned utility values. Preferred bundles of goods have a higher utility value than less desirable goods. This means that a utility function orders bundles of goods according to consumer preferences.

It is assumed that the utility function must meet certain conditions so that it can exist at all. In mathematics this means that the order of preference must be complete, transitive and strictly monotonic.

Only then does a utility function exist. If there is a utility function, indifference curves can be derived from it. Mathematically, the utility maximization problem can be posed as follows with the following mathematical formulation for a consumer with strictly monotonous preferences.

Benefit maximization problem: with 2 goods x [1], x [2] -> x [1] means x indexed 1

max u (x [1], x [2]) of the utility function of the goods x [1], x [2]

under the constraints: p [1] x x [1] + p [2] x x [2] = m

The optimal bundle of consumer goods is on the budget line. By calculating the maxima and minima, you can solve a utility function like in a curve discussion. A function with several variables can also be differentiated by taking the partial derivatives. The substitution method or the Lagrange method are methods for the mathematical solution of the utility maximization problem. The Cobb-Douglas utility function can be seen here as an example.

Simple example of reaching saturation

Assume: There are 6 pieces of value against 6 goods in the form of 6 groceries and 6 luxury goods each.

It follows that, according to the utility theory, the consumer first resorts to food and then to luxury goods. Saturation occurs, for example, with 4 foods for which he has used 4 pieces of value. The remainder of the 2 pieces of value can then be used for luxury goods.