Topic 1: Utility Theory and Welfare Economics

Background Information

This module discusses the utility theory and measurement of social welfare based on household and firm productions. The welfare theory is examined from the viewpoint of developing usable measures of change in consumer and producer welfare resulting from government action or interventions regarding private or public land use and use of other natural resources. This is the basis for economic valuation of forest ecosystem services. The measures discussed here are important not only in economic valuation, but also in benefit cost analysis and natural resource accounting.

Utility can be defined as a numerical score representing the satisfaction, benefit, or welfare that a consumer gets from a given market. For example, if an individual prefers Bundle A to Bundle B, then Bundle A gives more utility than Bundle B. It is an important concept in economics, because it represents satisfaction experienced by the consumer for a good or services. A good is something that satisfies human want. Since one cannot directly measure benefit, satisfaction, or happiness from a good or service, economists instead have devised ways of representing and measuring utility in terms of economic choices that can be measured. Economists have attempted to perfect highly abstract methods of comparing utilities by observing and calculating economic choices. In the simplest sense, economists consider utility to be revealed in people’s willingness to pay different amounts for different goods.

The measurement of welfare change has been discussed in detail by many authors in the most rigorous and pragmatic terms. The earliest work measured welfare effects based on changes in the prices people pay for the private goods. This concept has been applied to include public or non-market goods as well.

Lecture Presentation

Read and understand the following slide presentations

Utility and Welfare Economics

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Additional Resources

Article and Book

Read the following article and books:

Pagiola, S., von Ritter, K., & Bishop, J. (2004). Assessing the economic value of ecosystem conservation (Environment Department Paper No. 101). Washington, DC: The World Bank. Retrieved from

Zhang, D., & Stenger, A.(2014). Value and valuation of forest ecosystem services. Journal of Environmental Economics and Policy, DOI: 10.1080/21606544.2014.980852


Cornelis, G., & Kooten, v. (2004). Land and forest economics. Cheltenham: Edward Elgar. ISBN: 978 1 84376 881 4

Freeman III, A.M., Herriges, J.A., & Kling, C.L. (2014). The measurement of environemnatl and resource values: Theory and methods (3rd Edn). New York: Resources for the Future. ISBN 978-0-415-50157-6

Self-Reflection Questions

Please answer the following self-reflection questions. After formulating your answers, you may post them online at the Knowledge Café for this course as a way to share your ideas and glean knowledge from other students’ responses.

SrQ# 1.1: How do you relate utility and willingness to pay for valuing forest ecosystem services?

SrQ#1.2: Welfare measures are not only concerned with individual consumer or producer, but with consumers and producers overall. How do you use the aggregate of social welfare function to compare project or government programs?