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CARDINAL UTILITY AND ORDINAL UTILITY
MEANING OF UTILITY: Utility is the basis study of consumer behaviour. In economics the term utility refers to the capacity of a commodity to satisfy human wants.
DEFNITION OF UTILITY: According to BRIGG’S , “ utility is not only the measurement of satisfaction but also the measurement of intensity of satisfaction’’.
MEASUREMENT OF UTILITY Economists have offered their theories Of consumers behaviour on the basis of the measurement of utility. There are two major approaches to measure the utility: CARDINAL MEASUREMENT UTILITY. ORDINAL MEASUREMENT UTILITY.
Accordingly we have:
CARDINAL UTILITY THERORY OF CONSUMER BEHAVIOUR.
ORDINALY UTILITY THEROY OF CONSUMER BEHAVIOUR.
CARDINAL UTILITY OF CONSUMER BEHAVIOUR: MEANING OF CARDINAL UTILITY: Cardinal utility means the satisfaction of a consumer can be measured in terms of numbers.
The cardinal utility theory of consumer behaviour was given by PROF.MARSHALLIAN to define consumer equilibrium. PROF.MARSHALLIAN defines CARDINAL UTILITY as, “ consumer could measure the satisfaction derived by the consumption of any goods or services in terms of numbers and units. That unit is known as UTILS’’.
Marshallian have been explained the cardinal utility theory of consumer behaviour by :
THE LAW OF DIMINISHING MARGINAL UTILITY.
THE LAW OF EQUI-MARGINAL UTILITY.
TOTAL UTILITY: Total utility means the amount of utility derived from the consumption of all units of a commodity which are at the disposal of the consumer.
MARGINAL UTILITY: Marginal utility means the additional utility resulting from the consumption of an unit of a commodity.
LAW OF DIMINISHING MARGINAL UTILITY: According to MARSHALLIAN, “ The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has”.
EXAMPLE FOR LAW OF DMU: This law can be explained by the following example: Suppose a person start drinking juice. First glass of juice has a great utility for him. If he takes the second glass of juice, the utility will be less than the first and so on. The utility goes on diminishing with the consumption of every next unit and it drops down to zero. If the consumer is forced further, the utility will become negative.
SCHEDULE OF LAW OF DMU: UNITS 1st glass 2nd glass 3rd glass 4th glass 5th glass 6th glass
TOTAL UTILITY 10 18 24 28 30 30
MARGINAL UTILITY 10 8 6 4 2 0
7th glass
28
-2
LAW OF DIMINISHING MARGINAL UTILITY CURVE: Y
The OY-axis represents the marginal utility.
F
UTILITY
10
The OX-axis represents the units.
8 6 4 2
The FF1 curve represents the diminishing marginal utility.
0 1
2
3
4
-2
5
X
6 7 F1
UNITS
ASSUMPTIONS OF LAW OF DMU: o Tastes, preferences etc of the consumer remains unchanged. o Income of the consumer also remains constant. o Units of the goods are identical or similar. o
The process of consumption is
EXCEPTIONS OF LAW OF DMU: o The law of DMU is not applicable to money. o It is not applicable to rare collections like old stamps, old coins etc. o It is not applicable to the consumption of liquor.
LAW OF EQUI-MARGINAL UTILITY: It is the desire of every consumer that he wants to get maximum satisfaction from his limited resources. He can solve this problem if he spends his income in such a way that the last rupee spent on each item gives him the same amount of satisfaction. It is called the law of equi marginal utility.
Law of equi-marginal utility is also known as the LAW OF SUBSTITUTION. Because it is the only law by which the marginal utilities have been equalized through the law of substitution.
SCHEDULE OF LAW OF EQUIMARGINAL UTILITY: UNIT OF MONEY 1 2 3 4 5 TOTAL
MARGINAL UTILITY OF ICE-CREAM 10 8 6 4 2 30
MARGINAL UTILITY OF CHOCOLATE 8 6 4 2 0 20
LAW OF EQUI-MARGINAL UTILITY CURVE: Y
I
10 C
MRGINAL UTILITY
8 A
E
6 4 2
B
F
0 1
2
UNITS
3
C1 4
5
I1 X
The OX-axis represents the units. The OY-axis represents the marginal utility. The I & I1 represents the marginal utility curve of ice-cream. The C & C1 represents the marginal utility curve of chocolate. Then AB=EF the both utility are equal.
According to law of equi-marginal utility, a consumer will be at equilibrium when,
MUx/Px= MUy/Py
ASSUMPTION OF LAW OF EQUI-MARGINAL UTILITY: The income is limited in this law. The utility will be independent in this law. The utility can be measurable numerically in this law.
EXCEMPTIONS OF LAW OF EQUI-MARGINAL UTILITY: The utility is immeasurable so it is difficult to behave according to law. Sometimes due to ignorance's people don’t obtain the maximum advantage of the law. If the unit of expenditure is indivisible then this law will not operate.
ORDINAL UTILITY THEORY OF CONSUMER BEHAVIOUR: MEANING OF ORDINAL UTILITY: Ordinal utility refers to satisfaction of a consumer can be measure by ranking.
The ORDINAL UTILITY THEORY OF CONSUMER BEHAVIOUR was given by PROF.J.R.HICKS.
According to prof.J.R.HICKS “ORDINAL UTILITY means giving rank to the utility derived by the consumption of goods and services”.
“SCALE OF PREFERENES”:ORDINAL UTILITY Ordinal measurement implies comparison and ranking without quantification of the magnitude. Level of satisfaction is a function of increasing the stock of goods. The conceptual arrangement of combination of goods and services set in order of level of significance is called SCALE OF PREFRENCES.
EXAMPLE OF SCALE OF PREFRENCES. Combination b/w Level of apples and satisfaction bananas derived (a) 12 Apples + 12 Highest
Ranking order of preference
1st
Bananas (b)10 Apples + 19 Less than (a) Bananas (c)5 Apples + 5 Bananas
Less than (b)
2nd 3rd
CHARACTERISTICS OF SCALE OF PREFRENCES It is drawn by a consumer in his mind. It is based on the subjective valuation of goods made by the consumer. It is independent of the prices of goods and consumer’s income. Its differ from person to person. It represent ordinal comparison of the level of satisfaction derived by the consumer from different combination of goods.
DEFINATION OF INDIFFERNECE SCHEDULE An indifference schedule is a list of alternative combinations in the stocks of two goods which yield equal satisfaction to the consumer. An indifference schedule represents only equal satisfaction combinations at a particular order of preference while a scale of preference represents all combinations yielding different as well as equal levels of satisfaction.
EXAMPLE OF INDIFFERENT SCHEDULE Combination giving equal satisfaction
Apples (X)
Bananas (Y)
Marginal rate of substitution (ΔY)/(ΔX)
(a)
1
12
(b)
2
8
(c)
3
5
-3/1 = -3
(d)
4
3
-2/1 = -2
----4/1 = -4
DEFINATION INDIFFERENCE CURVE An indifference curve is the locus of points representing all the different combinations of two goods (say X and Y) which yield equal utility and satisfaction to the consumer. It is a geometrical device representing all such combinations of two goods yielding equal satisfaction at a particular level.
EXAMPLE OF INDIFFERENCE CURVE
INDIFFERENCE MAP An indifference map is a set of indifferent curves. An indifferences map represents the scale of the preferences of a consumer regarding various combination of the given two goods. In the example given in the next slide shows IC4 curve has highest satisfaction and IC1 curve has the lowest satisfaction.
EXAMPLE OF INDIFFERENCE MAP
ASSUMPTIONS A consumer is interested in buying two products
in combination. He is able to rank his preferences and give a complete ordering of the scale of preferences. Non-satiation, i.e., the consumer always prefers more quantities of goods to lesser quantity. He is rational and his choices are transitive. There is ordinal measurement of utility. so the height of the indifference curve indicates the level of satisfaction without quantification.
PROPERTIES OF INDIFFERENCE CURVE Indifference curve slope downwards from left
to right , i.e., they are negatively sloped. The are convex to the origin. They cannot intersect each other.
SIMILARITIES OF CARDINAL UTILITY AND ORDINAL UTILITY : Both the analysis are based on the assumption that the consumer is rational and he is interested to maximize his total utility.
Both the approaches follow the proportionality rule. In one it is between price and marginal utility while in the other it is between price and marginal rate of substitution. In Marshallian utility approach the equilibrium condition for a consumer is : MUx/Px=MUy/Py. In J.K.Hicks utility approach the equilibrium condition for a consumer is: MRSxy=Px/Py.
