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Utility: Cardinal utility approach, diminishing marginal utility, law of equi - marginal utility, ordinal utility approach


Human wants are unlimited and they are of different intensity. The means at the disposal of a man are not only scarce but they have alternative uses. As a result of scarcity of recourse, the consumer cannot satisfy all his wants. He has to choose as to which want is to be satisfied first and which afterward if the recourse permit. The consumer is confronted in making a choice.

For example, a man is thirsty. He goes to the market and satisfy his thirst by purchasing coca cola instead of tea. We are here to examine the economic forces which make him purchase a particular commodity. The answer is simple. The consumer buys a commodity because it gives him satisfaction. In technical term, a consumer purchases a commodity because it has utility for him. We now examine the tools which are used in the analyzes of consumer behavior.
Concept of Utility:

Jevon (1835 -1882) was the first economist who introduces the concept of utility in economics. According to him:

"Utility is the basis on which the demand of a individual for a commodity depends upon".

Utility is defined as:

"The power of a commodity or service to satisfy human want".

Utility is thus the satisfaction which is derived by the consumer by consuming the goods.

For example, cloth has a utility for us because we can wear it. Pen has a utility who can write with it. The utility is subjective in nature. It differs from person to person. The utility of a bottle of wine is zero for a person who is non drinker while it has a very high utility for a drinker.

Here it may be noted that the term ‘utility’ may not be confused with pleasure or unfullness which a commodity gives to an individual. Utility is a subjective satisfaction which consumer gets from consuming any good or service.

For example, poison is injurious to health but it gives subjective satisfaction to a person who wishes to die. We can say that utility is value neutral.

 

Assumptions of Cardinal Utility Analysis:


The main assumption or premises on which the cardinal utility analysis rests are as under.
 
(i) Rationality. The consumer is rational. He seeks to maximize satisfaction from the limited income which is at his disposal.
 
(ii) Utility is cardinally measurable. The utility can be measured in cardinal numbers such as 1, 3, 10, 15, etc. The utility is expressed in imaginary cardinal numbers tells us a great deal about the preference of the consumer for a good.
 
(iii) Marginal utility of money remains constant. Another important premise of cardinal utility of money spent on the purchase of a good or service should remain constant.
 
(iv) Diminishing marginal utility. It is also assumed that the marginal utility obtained from the consumption of a good diminishes continuously as its consumption is increased.
 
(v) Independent utilities. According to the Cardinalist school, the utility which is derived from the consumption of a good is a function of the quantity of that good alone. If does not depend at all upon the quantity consumed of other goods. The goods, we can say, possess independent utilities and are additive.
 
(vi) Introspection method. The Cardinalist school assumes that the behavior of marginal utility in the mind of another person can be judged with the help of self observation. For example, I know that as I purchase more and more of a good, the less utility I derived from the additional units of it. By applying the same principle, I can read other people mind and say with confidence that marginal utility of a good diminishes as they have more units of it.

Criticism:


Pareto, an Italian Economist, severely criticized the concept of cardinal utility. He stated that utility is neither quantifiable nor addible. It can, however be compared. He suggested that the concept of utility should be replaced by the scale of preference. Hicks and Allen, following the footsteps of Pareto, introduced the technique of indifference curves. The cardinal utility approach is thus replaced by ordinal utility function.
 
 

equimargtinal 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.

R.G.Lipsey Says, " The household maximizing is utility will allocate his expenditures between commodities in such a way that the utility of the last penny spent on each is equal."

Every consumer will substitute the more useful for the less useful thing. This law is also known as the law of substitution. It is called the law of Equi-Marginal Utility because it is only law by which the marginal utilities have been equalized through the process of substitution. This law can be explained with the help of following schedule, assuming that our consumer has only Rs. 5/- to spend. Further it is assumed that there are two commodities Apple and Orange.




According to this schedule if one consumer spends his Rs. 5/- on one thing then he will get only 30 or 20 units of satisfaction. To get maximum satisfaction a consumer will spend Rs. 3/- on Apple and Rs. 2/- on Orange. Because in this way the total amount of utility will be maximum.
When a consumer will spend Rs. 3/- on Apple he will get = 10 + 8 + 6 = 24
By spending two rupees on Oranges he will get = 8 + 6 = 14
Total amount of satisfaction will be 24 + 14 = 38

If he will adopt any other method, he would not get such amount of utility.So we find that when the marginal utilities ( 6 = 6 ) are equal the total utility is maximum. No combination will give him more satisfaction except this one.


EXPLANATION :- In this diagram MM' is the marginal utility curve of Apple. If consumer spends Rs. 3/- on Apple. The 3rd rupees utility is FG, KK' the marginal utility curve of orange. The last rupee utility is HJ. Both the marginal utilities FG = HJ.

LIMITATIONS OF THE LAW OF EQUI MARGINAL UTILITY

1. Unmeasurable concept :-
The concept of utility is unmeasurable so it is very difficult to behave according to the law.

2. Carelessness :-
Sometimes due to ignorance people do not obtain the maximum advantage by equating the marginal utilities.

3. Indivisible units :-
If the unit of expenditure is indivisible then this law will not operate.

4. Customs :-
People are slave of customs and traditions, so they use the goods like gold even there is less utility.

5. Freedom of choice :-
If there is no perfect freedom to choose between various commodities, then the law will not operate
 
 
 

Ordinal Utility Approach:

The basic idea behind ordinal utility approach is that a consumer keeps number of pairs of two commodities in his mind which give him equal level of satisfaction. This means that the utility can be ranked qualitatively.
The ordinal utility approach differs from the cardinal utility approach (also called classical theory) in the sense that the satisfaction derived from various commodities cannot be measured objectively.
Ordinal theory is also known as neo-classical theory of consumer equilibrium, Hicksian theory of consumer behaviour,  indifference curve theory, optimal choice theory. This approach also explains the consumer's equilibrium who is confronted with the multiplicity of objectives and scarcity of money income.
The important tools of ordinal utility are:
  1. The concept of indifference curves.
  2. The slop of I.C. i.e. marginal rate of substitution.
  3. The budget line.
The ordinal utility approach is based on the following assumptions:
  1. A consumer substitutes commodities rationally in order to maximize his level of satisfaction.
  2. A consumer can rank his preferences according to the satisfaction of each basket of goods.
  3. The consumer is consistent in his choices.
  4. It is assumed that each of the good is divisible.
  5. It is assumed that the consumer has full knowledge of prices in the market.
  6. The consumer's scale of preferences is so complete that consumer is indifferent between them.
  7. Two commodities are used by the consumer. It is also known as two commodities model.
  8. Two commodities X and Y are substitutes of each other. These commodities can be easily substituted in various pairs.

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