Utility and preferences are two key concepts in economics. They are an integral part of how economists analyze people’s choices. Understanding why people make the choices they do is fundamental to understanding demand for goods and services. Equally important is understanding how people make choices. The how is what determines the type of model we use to analyze choices. This will be the main focus of the blog series, but for now, we will focus on what we mean when we talk about utility and preferences.
A textbook definition of utility would be the happiness or total satisfaction you receive from consuming a good or service. If you are like me, this is a little wooly. Let us try and unpack that a little. When deciding the total satisfaction you receive from consumption, you tally up all of things that you don’t like, i.e. the attributes of the good that gives you no satisfaction (disutility), and the things you do like, i.e. the attributes of the good that gives you satisfaction (utility). The sum of your likes and dislikes from consumption is your total satisfaction or utility. Let us take an example. Assume now that you are considering eating an apple.
As you can see, it is not only physical attributes of the good that contributes to your utility, but factors in your immediate surroundings and even the working conditions of the farmer who produced the apple. To complicate matters even more, the potential future benefits of eating healthy now contributes to the utility you receive from consuming the apple.
Can you think of other attributes of eating an apple that would contribute to your utility? Positively? Negatively? Can you think of other examples?
Preferences and utility are closely linked. Before we continue, it is useful to think of how we can express utility in a useful way. Economists tend to assign a number to the utility you receive from consuming a good and call it a utile. Assigning utiles allow us to rank goods and services. Now, let us assume that you are considering a fruit snack, but this time, in addition to the apple, you can choose a banana. Now, let us assume that the utility you derive from eating the apple is 100 utiles and eating the banana gives you 200 utiles. This means that you derive more pleasure from eating the banana than the apple. You prefer the banana to the apple. However, it does not mean that you prefer a banana twice as much as an apple. Utiles allows us to rank goods without saying anything about their relative importance.
The concept of utility and preferences allows us to rank an infinite number of goods and services. Now, let us assume that a third fruit option became available, a pear, and that the utility you derive from consuming it is 150. Now, we can say that you prefer a pear to an apple and a banana to both pears and apples.