CARDINAL UTILITY CARDINAL UTILITY AND ORDINAL UTILITYAND ORDINAL UTILITY

MEANING OF UTILITY:MEANING OF UTILITY:

Utility is the basis study of Utility is the basis study of consumer behaviour. consumer behaviour.

In economics the term utility In economics the term utility refers to the capacity of a commodity refers to the capacity of a commodity to satisfy human wants.to satisfy human wants.

DEFNITION OF UTILITY:DEFNITION OF UTILITY:

According to BRIGG’S , “ According to BRIGG’S , “ utility is not only the utility is not only the measurement of satisfaction but measurement of satisfaction but also the measurement of also the measurement of intensity of satisfaction’’.intensity of satisfaction’’.

MEASUREMENT OF UTILITYMEASUREMENT OF UTILITY

Economists have offered their Economists have offered their theoriestheoriesOf consumers behaviour on the Of consumers behaviour on the basis of the measurement of utility. basis of the measurement of utility. There are two major approaches to There are two major approaches to measure the utility:measure the utility:

CARDINAL MEASUREMENT CARDINAL MEASUREMENT UTILITY.UTILITY.

ORDINAL MEASUREMENT ORDINAL MEASUREMENT UTILITY.UTILITY.

Accordingly we have:Accordingly we have:

CARDINAL UTILITY THERORY OFCARDINAL UTILITY THERORY OF CONSUMER BEHAVIOUR.CONSUMER BEHAVIOUR.

ORDINALY UTILITY THEROY OF ORDINALY UTILITY THEROY OF CONSUMER BEHAVIOUR.CONSUMER BEHAVIOUR.

CARDINAL UTILITY OF CARDINAL UTILITY OF CONSUMER CONSUMER BEHAVIOUR:BEHAVIOUR:

MEANING OF CARDINAL UTILITY:MEANING OF CARDINAL UTILITY:

Cardinal utility means the Cardinal utility means the satisfaction of a consumer satisfaction of a consumer can be measured in terms of can be measured in terms of numbers.numbers.

The cardinal utility theory of The cardinal utility theory of consumer behaviour was given by consumer behaviour was given by PROF.MARSHALLIANPROF.MARSHALLIAN to define to define consumer equilibrium.consumer equilibrium.

PROF.MARSHALLIAN defines PROF.MARSHALLIAN defines CARDINALCARDINAL UTILITY UTILITY as, “ consumer as, “ consumer could measure the satisfaction could measure the satisfaction derived by the consumption of any derived by the consumption of any goods or services in terms of goods or services in terms of numbers and units. That unit is numbers and units. That unit is known as known as UTILSUTILS’’.’’.

Marshallian have been explained Marshallian have been explained the cardinal utility theory of the cardinal utility theory of consumer behaviour by :consumer behaviour by :

THE LAW OF THE LAW OF DIMINISHING MARGINAL DIMINISHING MARGINAL UTILITY.UTILITY.

THE LAW OF EQUI-THE LAW OF EQUI-MARGINAL UTILITY. MARGINAL UTILITY.

TOTAL UTILITY:TOTAL UTILITY: Total utility means the amount of Total utility means the amount of utility derived from the utility derived from the consumption of all units of a consumption of all units of a commodity which are at the disposal commodity which are at the disposal of the consumer.of the consumer.

MARGINAL UTILITY:MARGINAL UTILITY: Marginal utility means the Marginal utility means the additional utility resulting from the additional utility resulting from the consumption of an unit of a consumption of an unit of a commodity.commodity.

LAW OF DIMINISHING LAW OF DIMINISHING MARGINAL UTILITY:MARGINAL UTILITY:

According to MARSHALLIAN, “ According to MARSHALLIAN, “ The additional benefit which a The additional benefit which a person derives from a given person derives from a given increase of his stock of a thing increase of his stock of a thing diminishes with every increase in diminishes with every increase in the stock that he already has”. the stock that he already has”.

EXAMPLE FOR LAW OF DMU:EXAMPLE FOR LAW OF DMU:

This law can be explained by the This law can be explained by the following example:following example: Suppose a person start drinking Suppose a person start drinking juice. First glass of juice has a great juice. First glass of juice has a great utility for him. If he takes the second utility for him. If he takes the second glass of juice, the utility will be less glass of juice, the utility will be less than the first and so on. The utility than the first and so on. The utility goes on diminishing with the goes on diminishing with the consumption of every next unit and it consumption of every next unit and it drops down to zero. If the consumer drops down to zero. If the consumer is forced further, the utility will is forced further, the utility will become negative. become negative.

SCHEDULE OF LAW OF DMU:SCHEDULE OF LAW OF DMU:UNITSUNITS TOTAL TOTAL

UTILITYUTILITYMARGINAMARGINAL UTILITYL UTILITY

11stst glass glass 1010 10 10

22ndnd glass glass 1818 883rd glass 2424 664th glass 2828 445th glass 3030 226th glass 3030 00

77thth glass glass 2828 -2-2

LAW OF DIMINISHING LAW OF DIMINISHING MARGINAL UTILITY MARGINAL UTILITY CURVE:CURVE:

10

86

42

0

-2 1 2 3 4 5 6 7

F

F1

Y

X

UNITSUNITS

MA

RG

INA

L

MA

RG

INA

L

UT

ILIT

YU

TIL

ITY

The OY-axis represents The OY-axis represents the marginal utility.the marginal utility.

The OX-axis represents The OX-axis represents the units.the units.

The FF1 curve represents The FF1 curve represents the diminishing marginal the diminishing marginal utility.utility.

ASSUMPTIONS OF LAW ASSUMPTIONS OF LAW OF DMU:OF DMU:o Tastes, preferences etc of the Tastes, preferences etc of the

consumer remains unchanged.consumer remains unchanged.

o Income of the consumer also Income of the consumer also remains constant.remains constant.

o Units of the goods are identical Units of the goods are identical or similar.or similar.

o The process of consumption is The process of consumption is continuous.continuous.

EXCEPTIONS OF LAW OF EXCEPTIONS OF LAW OF DMU:DMU:

o The law of DMU is not The law of DMU is not applicable to money.applicable to money.

o It is not applicable to rare It is not applicable to rare collections like old stamps, old collections like old stamps, old coins etc.coins etc.

o It is not applicable to the It is not applicable to the consumption of liquor.consumption of liquor.

LAW OF EQUI-MARGINAL LAW OF EQUI-MARGINAL UTILITY:UTILITY:

It is the desire of every consumer It is the desire of every consumer that he wants to get maximum that he wants to get maximum satisfaction from his limited satisfaction from his limited resources. He can solve this resources. He can solve this problem if he spends his income problem if he spends his income in such a way that the last rupee in such a way that the last rupee spent on each item gives him the spent on each item gives him the same amount of satisfaction. It is same amount of satisfaction. It is called the law of equi marginal called the law of equi marginal utility.utility.

Law of equi-marginal utility Law of equi-marginal utility is also known asis also known asthe the LAW OF SUBSTITUTIONLAW OF SUBSTITUTION. . Because it is the only law by which Because it is the only law by which the marginal utilities have been the marginal utilities have been equalized through the law of equalized through the law of substitution.substitution.

SCHEDULE OF LAW OF SCHEDULE OF LAW OF EQUI-MARGINAL EQUI-MARGINAL UTILITY:UTILITY:UNIT OF UNIT OF MONEYMONEY

MARGINAMARGINAL UTILITY L UTILITY OF ICE-OF ICE-CREAMCREAM

MARGINAMARGINAL UTILITY L UTILITY OF OF CHOCOLACHOCOLATETE

11 1010 88

22 88 66

33 66 44

44 44 22

55 22 00

TOTALTOTAL 3030 2020

LAW OF EQUI-LAW OF EQUI-MARGINAL UTILITY MARGINAL UTILITY CURVE:CURVE:10

8

64

2

0 1 2 3 4 5

Y

X

I

I1

C

C1

UNITUNITSS

MR

GIN

AL

M

RG

INA

L

UT

ILIT

YU

TIL

ITY

A

B

E

F

The OX-axis represents the units.The OX-axis represents the units.

The OY-axis represents the The OY-axis represents the marginal utility.marginal utility.

The I & I1 represents the The I & I1 represents the marginal utility curve of ice-marginal utility curve of ice-cream.cream.

The C & C1 represents the The C & C1 represents the marginal utility curve of marginal utility curve of chocolate.chocolate.

Then AB=EF the both utility are Then AB=EF the both utility are equal.equal.

According to law of equi-marginal According to law of equi-marginal utility, a consumer will be at utility, a consumer will be at equilibrium when,equilibrium when,

MUx/Px= MUx/Px= MUy/Py MUy/Py

ASSUMPTION OF LAW ASSUMPTION OF LAW OF EQUI-MARGINAL OF EQUI-MARGINAL UTILITY:UTILITY:

The income is limited in this The income is limited in this law.law.

The utility will be independent The utility will be independent in this law.in this law.

The utility can be measurable The utility can be measurable numerically in this law.numerically in this law.

EXCEMPTIONS OF LAW EXCEMPTIONS OF LAW OF EQUI-MARGINAL OF EQUI-MARGINAL UTILITY:UTILITY: The utility is The utility is immeasurable so it is so it is difficult to behave according to law.difficult to behave according to law.

Sometimes due to ignorance's Sometimes due to ignorance's people don’t obtain the maximum people don’t obtain the maximum advantage of the law.advantage of the law.

If the unit of expenditure is indivisible then this law will not operate.

ORDINAL UTILITY ORDINAL UTILITY THEORY OF CONSUMER THEORY OF CONSUMER BEHAVIOUR:BEHAVIOUR:

MEANING OF ORDINAL MEANING OF ORDINAL UTILITY:UTILITY:

Ordinal utility Ordinal utility refers to satisfaction of a refers to satisfaction of a consumer can be measure by consumer can be measure by ranking. ranking.

The ORDINAL UTILITY THEORY OF The ORDINAL UTILITY THEORY OF CONSUMER BEHAVIOUR was given CONSUMER BEHAVIOUR was given by by PROF.J.R.HICKSPROF.J.R.HICKS..

According to prof.J.R.HICKS According to prof.J.R.HICKS “ORDINAL UTILITY means giving “ORDINAL UTILITY means giving rank to the utility derived by the rank to the utility derived by the consumption of goods and services”.consumption of goods and services”.

““SCALE OF SCALE OF PREFERENES”:ORDINAL PREFERENES”:ORDINAL UTILITYUTILITY

Ordinal measurement implies Ordinal measurement implies comparison and ranking without comparison and ranking without quantification of the magnitude.quantification of the magnitude.

Level of satisfaction is a function of Level of satisfaction is a function of increasing the stock of goods.increasing the stock of goods.

The conceptual arrangement of The conceptual arrangement of combination of goods and services set combination of goods and services set in order of level of significance is called in order of level of significance is called SCALE OF PREFRENCES.SCALE OF PREFRENCES.

EXAMPLE OF SCALE OF EXAMPLE OF SCALE OF PREFRENCES.PREFRENCES.Combination Combination b/w apples and b/w apples and bananasbananas

Level of Level of satisfaction satisfaction derivedderived

Ranking order Ranking order of preferenceof preference

(a) 12 Apples (a) 12 Apples + 12 Bananas+ 12 Bananas

HighestHighest 11stst

(b)10 Apples (b)10 Apples + 19 Bananas+ 19 Bananas

Less than (a)Less than (a) 22ndnd

(c)5 (c)5 Apples + Apples + 55 BananasBananas

Less than (b)Less than (b) 33rdrd

CHARACTERISTICS OF CHARACTERISTICS OF SCALE OF PREFRENCESSCALE OF PREFRENCESIt is drawn by a consumer in his mind.It is drawn by a consumer in his mind.It is based on the subjective valuation It is based on the subjective valuation

of goods made by the consumer.of goods made by the consumer.It is independent of the prices of goods It is independent of the prices of goods

and consumer’s income.and consumer’s income.Its differ from person to person.Its differ from person to person.It represent ordinal comparison of the It represent ordinal comparison of the

level of satisfaction derived by the level of satisfaction derived by the consumer from different combination consumer from different combination of goods.of goods.

DEFINATION OF DEFINATION OF INDIFFERNECE INDIFFERNECE SCHEDULESCHEDULE

An indifference schedule is a list of An indifference schedule is a list of alternative combinations in the stocks of alternative combinations in the stocks of two goods which yield equal satisfaction two goods which yield equal satisfaction to the consumer. An indifference to the consumer. An indifference schedule represents only equal schedule represents only equal satisfaction combinations at a particular satisfaction combinations at a particular order of preference while a scale of order of preference while a scale of preference represents all combinations preference represents all combinations yielding different as well as equal levels yielding different as well as equal levels of satisfaction.of satisfaction.

EXAMPLE OF EXAMPLE OF INDIFFERENT SCHEDULEINDIFFERENT SCHEDULECombinatiCombination giving on giving equal equal satisfactiosatisfactionn

ApplesApples (X)(X)

BananasBananas (Y)(Y)

Marginal Marginal rate of rate of substitutisubstitution(on(ΔΔY)/(Y)/(ΔΔX)X)

(a)(a) 1 12 ----(b)(b) 2 8 -4/1 = -

4(c)(c) 3 5 -3/1 = -3(d)(d) 4 3 -2/1 = -2

DEFINATION DEFINATION INDIFFERENCE CURVEINDIFFERENCE CURVE

An indifference curve is the locus of An indifference curve is the locus of points representing all the different points representing all the different combinations of two goods (say X and combinations of two goods (say X and Y) which yield equal utility and Y) which yield equal utility and satisfaction to the consumer. It is a satisfaction to the consumer. It is a geometrical device representing all geometrical device representing all such combinations of two goods such combinations of two goods yielding equal satisfaction at a yielding equal satisfaction at a particular level.particular level.

EXAMPLE OF EXAMPLE OF INDIFFERENCE CURVEINDIFFERENCE CURVE

INDIFFERENCE MAPINDIFFERENCE MAP

An indifference map is a set of An indifference map is a set of indifferent curves. An indifferences indifferent curves. An indifferences map represents the scale of the map represents the scale of the preferences of a consumer regarding preferences of a consumer regarding various combination of the given two various combination of the given two goods. In the example given in the goods. In the example given in the next slide shows IC4 curve has next slide shows IC4 curve has highest satisfaction and IC1 curve has highest satisfaction and IC1 curve has the lowest satisfaction.the lowest satisfaction.

EXAMPLE OF EXAMPLE OF INDIFFERENCE MAPINDIFFERENCE MAP

ASSUMPTIONSASSUMPTIONSA consumer is interested in buying two products A consumer is interested in buying two products

in combination.in combination.He is able to rank his preferences and give a He is able to rank his preferences and give a

complete ordering of the scale of preferences.complete ordering of the scale of preferences.Non-satiation, i.e., the consumer always prefers Non-satiation, i.e., the consumer always prefers

more quantities of goods to lesser quantity.more quantities of goods to lesser quantity.He is rational and his choices are transitive.He is rational and his choices are transitive.There is ordinal measurement of utility. so the There is ordinal measurement of utility. so the

height of the indifference curve indicates the height of the indifference curve indicates the level of satisfaction without quantification.level of satisfaction without quantification.

PROPERTIES OF PROPERTIES OF INDIFFERENCE CURVEINDIFFERENCE CURVE

Indifference curve slope downwards Indifference curve slope downwards from left to right , i.e., they are from left to right , i.e., they are negatively sloped.negatively sloped.

The are convex to the origin.The are convex to the origin.They cannot intersect each other.They cannot intersect each other.

SIMILARITIES OF SIMILARITIES OF CARDINAL UTILITY CARDINAL UTILITY AND ORDINAL AND ORDINAL UTILITY :UTILITY :

Both the analysis are based on Both the analysis are based on the assumption that the the assumption that the consumer is rational and he is consumer is rational and he is interested to maximize his total interested to maximize his total utility.utility.

Both the approaches follow the Both the approaches follow the proportionality rule. In one it is proportionality rule. In one it is between price and marginal between price and marginal utility while in the other it is utility while in the other it is between price and marginal rate between price and marginal rate of substitution.  of substitution.  

In Marshallian utility approach In Marshallian utility approach the equilibrium condition for a the equilibrium condition for a consumer is :consumer is :MUx/Px=MUy/Py. In J.K.Hicks MUx/Px=MUy/Py. In J.K.Hicks utility approach the equilibrium utility approach the equilibrium condition for a consumer is: condition for a consumer is: MRSxy=Px/Py.MRSxy=Px/Py.

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