Teaching Guide: Utility & Preferences

Learning Objectives

After completing this lesson, you will be able to:

  • Differentiate between cardinal and ordinal utility
  • Define assumptions of consumer preferences

Summary

A consumer’s preferences are typically defined based on a set of assumptions that focus on choices consumers must make. Those choices result in different levels of utility (happiness) and depending on their income, but this lesson focuses first on understanding the preferences side of the decision.

There are three basic assumptions that are important for evaluating consumer preferences: completeness, transitivity, and non-satiation. In the scene below, we can a variant of these three assumptions as Glenn must decide which employees he must fired. The Cloud 9 Corporate office has asked Glenn to name 6 employees he can let go, but he’s having trouble deciding.

Cardinal vs Ordinal Utility

Utility can be measured in two ways: cardinal and ordinal. Ordinal utility is based on a ranking of the options. The ranking doesn’t show how much more valuable one option is compared to another, but only that one option is preferred over the other. In the scene above, Glenn and Amy go through the process of assigning values (initially on a scale of 1 to 10) so that they can rank employees. The higher the score, the less likely they are to be fired. The individual score, like Mateo receiving a 43, does not mean that he’s 4.3 times more valuable than Elias who earned a score of 10.

Consumer Preference Assumptions

There are three primary assumptions of consumer preference that can be identified in the scene above. The completeness assumption assumes that each decision maker has a preference for one good over another. There can be no indifference for the decision maker. The transitivity assumption assumes that preferences can be ranked and that there aren’t circular preferences. This is occasionally considered the “ranking” assumption. The non-satiation assumption assumes that more is better.

Have students work in pairs to use the scene above to outline how Glenn’s decision making process meets each of the three assumptions.

Suggested answer:

Completeness: Glenn lays out photos of each employees and works through each of them to determine a score. He does not assume that every one is identical.

Transitivity: Each worker is assigned a unique number to order the workers so that higher numbers represent his preferred employee. No workers have the same number.

Non-satiation: Glenn wants to keep all of his employees and is struggling to fire any of them. He mentions he only hires good people and he would like to have more if he could.