What are Preferences and Utility?

Before understanding what is preference and utility analysis, it is very important to understand the terms preference and utility separately.

Preference refers to the phenomena in which the consumer will choose to consume a particular kind of product or commodity irrespective of the fact of its price availability and so on whereas, utility means the level of satisfaction a consumer or individual is getting after his or her consumption of some goods or commodities.

In economic theory, specifically in microeconomic theory, the term utility is used to describe the satisfaction or the pleasure that an individual or a consumer obtains from the consumption of his or her preference of goods and services or commodities. This can be understood with the help of an example: suppose that an individual is having three choices to do on a Sunday evening, either he or she can watch television, or he or she can go to play basketball or he or she can go out for a dinner. Now depending upon his or her preferences, that individual will decide that how will he or she rank the level of utility to each of these three activities that he or she likes to do. Since it is not possible to measure utility in terms of number, one can rank the utility of the activities or the utility which we get from goods and services or commodities in terms of which utility is higher or which utility is lower.

Types of Utility

The evaluation or analysis of preference and utility is done to explain the behavior of the individual or consumer from time to time. There are mainly two theories that explain the utility analysis:

1. Cardinal utility analysis- marginal utility analysis
2. indifference curve analysis- ordinal utility analysis

In other words, it can be said that utility may be defined as the amount of satisfaction or pleasure which is being derived from the consumption of a commodity or a good.

Certain Characteristics of Utility

• The utility is subjective: Utility is considered to be subjective because the preferences of an individual depend on his or her choice. Therefore, it is on the individual to estimate what amount of satisfaction that he or she is likely to get from a commodity.
• The utility is different from usefulness: Generally, it is understood that utility means how useful a commodity or a good to the individual is. But this is not the case. For example, smoking may have harmful effects, but even then, it is having some kind of utility to the chain smoker because it satisfies the smoking desire of the individual. It can also be considered that smoking is of no use to an individual until and unless he is a chain smoker. The utility of the cigarette to the smoker is that it satisfies the desire of smoking but it is actually of no help or uses to an individual.
• The utility is relative in nature: This is for the fact that utility is subjective in nature. This means that the utility of a good or a commodity to an individual depends on his or her intensity of desire for that particular commodity; the greater the need of the commodity, the greater will be the utility of that commodity to the individual who is desiring it. Therefore, the utility of goods and services or commodities varies from person to person depending upon their preferences.

There are Certain Concepts under Utility which is important to Understand

• Total utility: It refers to the total amount of satisfaction or pleasure derived by the consumer from the consumption of a specific quantity of a particular commodity. For example, in the case of chocolate, the total utility of consuming two chocolates is the total satisfaction that these two chocolates provide.
• Marginal utility: Marginal utility refers to the satisfaction that is derived from the consumption of an additional unit of any commodity. For example, earlier (say), John was consuming 2 units of chocolates which were giving him some amount of total utility, now when he consumes the additional unit, which means the third unit of the chocolate, the satisfaction this third unit gives to him, is called the marginal utility of the third unit of chocolate.

For the ease of understanding the concept of utility, the unit called utils to measure utility is used.

From the above table, it can be interpreted that when an individual is consuming one unit of chocolate, he or she is deriving 20 units of utility. In this case, the concept of utility is measured in terms of numbers so that it becomes easier to understand the concept of total utility and marginal utility. Now when John was consuming the second unit of the chocolate it is giving him 34 units of total utility. This means that when he is consuming the second unit of the chocolate, he is getting 14 units more utility. But if in the first case when he wants to consume no unit of chocolate his utility was also zero but when he consumes the first unit of chocolate it became 20 units but when he is consuming the second unit of chocolate it is becoming 14 units hence when he is consuming an additional unit of the chocolate his total utility is increasing but it decreased marginally.

The above table implies the marginal utility is that how much each additional unit of chocolate is giving the utility when it is consumed. For example, when he is consuming the third unit of the chocolate the total utility is increasing from 34 to 42 but the increase in the utility from the consumption of the third unit of chocolate is 8 therefore this concept is known as marginal utility

Therefore, briefly it can be said that:

• Total utility= the sum of all marginal utilities.
• Marginal utility= the addition made to the total utility by the consumption of one more unit of a commodity.

The relationship between the marginal utility and total utility can be said in the following manner:

• Total utility increases as long as marginal utility is positive.
• Total utility is the maximum when the marginal utility is 0.
• Total utility decreases as the marginal utility become negative.

Law of Diminishing Marginal Utility

The theory of law of diminishing marginal utility can be explained in a manner which states that as an individual consumes an additional unit of some commodity within a particular period of time, the total utility increases, but the additional unit of the consumption of some commodity gives less utility than the previous one.

This can be understood with the help of an example: suppose that John is in a desert and he is badly in need of some water. After walking for some distance, he finds a place where he can get cool water, therefore now he becomes happy and wants to have some water to quench his thirst. Therefore, he goes to that place and purchases the amount of water he needs to quench his thirst. Initially, he thinks the first glass of water that will give him an extreme level of satisfaction of utility as he required water for a very long time. Now he consumes the second glass of water. The second glass of water won't give him that immense satisfaction that he has already got from the first glass of water. But in some way or the other, he will be satisfied. now he consumes the third glass of water, this is the point where he was completely satiated. Therefore, now his utility or the marginal utility becomes 0 because on the third glass of water he does not feel any level of satisfaction. Now when he further wants to consume water, he won't get any kind of satisfaction rather he will not want to anymore water. But due to some reason or the other, if he is compelled to have that 4th glass of water, this will give him some amount of dissatisfaction and this is the point when his total utility starts to reduce and his marginal utility becomes completely negative. This example entirely explains the concept of diminishing marginal utility. Therefore, it can be said that as one consumes additional units of any commodity that leads to the decrease of the marginal utility. This is known as the law of diminishing marginal utility which was pro founded by Alfred Marshall.

Indifference Curve Analysis

The indifference curve analysis is based on the notion of a particular scale of preference on the side of the consumer as between different combinations of two goods. A quantity of two commodities consumed by any individual is known as the combination of those two commodities or in other words, they are called bundles.

 In other words, an indifference curve shows various combinations of two commodities that give an equal amount of satisfaction to the consumer. It can be said that the consumer is in some way indifferent between the two combinations, he is only concerned with the total utility that he wants to get from those two combinations. In this case, the consumer always needs to trade off some commodity in need of the other commodity so that his total utility remains constant.

Assumptions of Indifferent Curve Analysis

• Rationality: In the analysis or evaluation of the indifference curve it is assumed that the consumer is rational. This means that his or her only goal while completing the process of consumption is to maximize the utility or his total satisfaction. In short, the objective of the consumer in the case of indifference curve analysis is always to maximize his or her utility.
• Ordinal utility: It is assumed that the consumer always uses the method of ranking his or her preference through the approach that which commodity gives him or her higher or lower utility than the other commodity. In other words, the indifference curve approach always works on empirical data rather than numerical data.
• Transitivity of choice: Individual preferences based are assumed to be transitive. This means that if the consumer prefers bundle A to bundle B and bundle B to bundle C then he or she will prefer bundle A to bundle C.

Context and Applications  

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

• B.A. in economics
• M.A. in economics