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Cardinal utility approach is also known as classical approach because it was presented by classical economists. Concepts of Utility: Following are important concepts of utility: Utility: The characteristics of a commodity or service is to satisfy a human want. The amount of satisfaction a person derives from some commodity or service, is called utility. Total Utility: The amount of satisfaction a person derives from some commodity or service over a period of time, is called utility. In other words, it is the sum of marginal utilities obtained from consumption of each successive unit of a commodity or service. If continuous units of a commodity 'X' are consumed, then TUx = ∑ MUx Marginal Utility: The extra amount of satisfaction to be obtained from having an additional increment of a commodity or service. In brief, the change in total utility resulting from one unit change in the consumption of a commodity or service per unit of time is called marginal utility. The following formula may be used to measure it. Marginal utility = Change in total utility / Change in quantity consumed or MU = ∆TU / ∆Q or MU = d TU / d Q Initial Utility: The amount of satisfaction to be obtained from the consumption of very first unit of a commodity or service is called the initial utility e.g. the amount of satisfaction to be obtained from consumption of the first apple is units. It is called initial utility of the consumer. Positive Utility: When a consumer consumes successive units of a commodity or service, its marginal utility decreases. The utility obtained from the consumption of all the units of a commodity or service before reaching the marginal utility equal to zero, is called positive utility.
Saturation Point: By the consumption of that unit of a commodity where the marginal utility drops down to zero, is called the saturation point. Negative Utility: By using the next unit of a commodity after saturation point, that unit gives negative satisfaction to the consumer and marginal utility becomes negative, it is known as negative utility.\ Util: Although utility cannot be measured but in cardinal approach of consumer behavior, the term which is used as a unit of utility is known as util and arithmetic numbers (1, 2, 3, .......) are used. For example X ate an apple and got 10 util of utility. 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 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.
the marginal utility diminishes constantly". E.8. of the law further to take a glass of water. It is necessary that a standard unit of measurement is constant 4. then the consumer may have no utility in open shirts. 10. 5. D. A commodity is being taken continuously. the MU becomes negative. When the MU curve goes beyond this point. because he is very thirsty. For example. ultimately. By taking the seventh glass of water. 7. the points A. When he takes 2nd glass of water. The marginal utility of the successive glasses of water decreases. After this point the marginal utility becomes negative. the marginal utility of different glasses of water is measured on the y-axis and the units (glasses of water) on X-axis. if he is forced On taking the 1st glass of water. The utility is measurable and a person can express the utility derived from a commodity in qualitative terms such as 2 units. if there is a fashion of lifted shirts. 3. The marginal utility of a commodity diminishes at the consumer gets larger quantities of it. Two commodities X and Y are substitutes of each other. Exceptions or Limitations: The limitations or exceptions of the law of diminishing 2 . F and G are derived by the different combinations of units of the commodity (glasses of water) and the marginal utility gained by different units of commodity. his marginal utility goes down to 8 units because his thirst has been partly satisfied. we get the marginal utility curve. the demand for CNG increases due to rise in the prices of petroleum and these price changes effect the utility of CNG. By joining these points. Assumptions: Following are the assumptions of diminishing marginal utility. 2. It is assumed that the commodity is divisible. With the help of the schedule. There should be proper units of a good consumed by the consumer. At this point "F" the marginal utility becomes zero. It is assumed that the prices of the substitutes do not change. the marginal utility becomes negative because the thirst of the consumer has already been fully satisfied. C. Income of the consumer remains constant during the operation of the law of diminishing marginal utility. B. It intersects the X-axis at the point of 6th unit of the commodity. He takes the glasses of water successively. the consumer gets 10 units of utility. The law of diminishing marginal utility can be explained by the following diagram drawn with the help of above schedule: In the above figure. The behaviour of the consumer is indicated in the following schedule: Units of commodity 1st glass 2nd glass 3rd glass 4th glass 5th glass 6th glass 7th glass Marginal utility 10 8 6 4 2 0 -2 Total utility 10 18 24 28 30 30 28 1. The taste of the consumer remains same during the consumption o the successive units of commodity. So there is an inverse functional relationship between the units of a commodity and the marginal utility of that commodity. The marginal utility curve has the downward negative slope. Marginal utility is the change in the total utility resulting from one unit change in the consumption of a commodity per unit of time. For example. Law of Diminishing Marginal Utility: Definition of the Law: "Other things remaining the same when a person takes successive units of a commodity. 9. This process continues until the marginal utility drops down to zero which is the saturation point. A rational consumer aims at the maximization of his utility. There should be not change in fashion. he reaches the point of satiety. It is assumed that various units of commodity homogeneous in characteristics. Explanation With Schedule and Diagram: We assume that a man is very thirsty. Any gap between the consumption of a commodity should be suitable. 4 units and 7 units etc. 11. 8. 6. These commodities can be easily substituted in various pairs.
imposing a heavier burden on the rich people. Consumer has perfect knowledge of utility obtained from goods. The total utility he can get is: [(10) + (8+7+6+5+4)] = 40. It is clear that consumer can get maximum utility from the expenditure of his limited income. By purchasing more of a commodity the marginal utility decreases. 6. The consumer can get maximum utility by allocating income among commodities in such a way that last dollar spent on each item provides the same marginal utility. When he buys several things with given money income he equalizes The above schedule shows that consumer can spend six dollars in different ways: 1. 3. consumer surplus and the law of substitution etc. The marginal utility of money is constant. He tries to spend limited income on different things in such a way that marginal utility of all things is equal. $1 on apples and $5 on bananas. 7. On the other hand its utility goes down if it goes out of fashion. Explanation With Schedule and Diagram: The law of substitution can be explained with the help of an example. There is no change in the prices of the goods. Due to this behaviour. The income of consumer is fixed. Definition: "A person can get maximum utility with his given income when it is spent on different commodities in such a way that the marginal utility of money spent on each item is equal". the consumer cuts his expenditures to that commodity. The value of commodity falls by increasing the supply of a commodity. stamps etc. In the field of public finance. drunkard is said to enjoy each successive peg more than the previous one. 3. It does not apply to the knowledge. If a dress comes in fashion. Consumer has many wants. 3. 5. H. Man is fond of beauty and decoration. collection of ancient coins. Gossen. 3 . The law of equi marginal utility is an extension of the law of diminishing marginal utility. Historical things are also included in exceptions to the law. This law is the base of some other economic laws such as law of demand. The law is not applicable for precious goods. 7. 4. this law has a practical application. 6. He should purchase such amount of each commodity that the last unit of money spend on each item provides same marginal utility. The marginal utility of money declines with richness but never falls to zero. He gets more satisfaction by getting the above merits of the commodities. It is also known as law of maximum satisfaction or law of substitution or Gossen's second law. elasticity of demand. 4. 2. 5. The following table shows marginal utility (MU) of spending additional dollars of income on apples and bananas: MU of apples 10 9 8 7 6 5 MU of bananas 8 7 6 5 4 3 Money (Units) 1 2 3 4 5 6 Law of Equi Marginal Utility: The law of equi marginal utility was presented in 19th century by an Australian economists H. Suppose consumer has six dollars that he wants to spend on apples and bananas in order to obtain maximum total utility.marginal utility are as follows: 1. The utility is measurable in cardinal terms. 4. The utility increases due to demonstration. 2. For example. For example. Law does not operate if consumer behaves in irrational manner. 8. The goods have substitutes. its utility goes up. It is a natural element. 2. 9. art and innovations. The law does not hold well in the rare collections. Importance of the Law of Diminishing Marginal Utility: The importance or the role of the law of diminishing marginal utility is as follows: 1. In this way prices are determined marginal utilities of all such things. Consumer is normal person so he tries to seek maximum satisfaction. 8. It forms a basis of the theory of value. The law is not fully applicable to money. A consumer has number of wants. Assumptions of the Law of Equi Marginal Utility: 1.
They can compare the marginal utility of work and the marginal utility of rest. A rational consumer tries to get maximum satisfaction when he spends his limited resources on various things. The does not work due to unlimited resources. The law is not applicable in case of durable goods. The does not hold well in case of very low income. The government can spend its revenue to get maximum social advantage. 5. The consumer can make choice between present wants and future wants. 2. He will substitute saving and The diagram shows that consumer has income of six dollars. The total utility he can get is: [(10+9+8) + (8+7+6)] = 48. 5. They can decide working hours and rest hours.e 7 = 7 is also satisfied. Any other allocation of the last dollar shall give less total utility to the consumer. trade. The law is not applicable in case of knowledge. National income is distributed among factors of production according to this law. Reading of books provides more satisfaction and knowledge to the scholar. The consumer is unable to divide the goods to adjust units of utility derived from consumption of goods. There is no measurement of utility. The law is applicable in consumption. The law holds well in case of saving and spending. An entrepreneur can pay factors of production equal to marginal product measured in money terms. There may be unlimited resources. The law is helpful in exchange of wealth. 6. The law is useful for workers in allocating the time between work and rest. There is no need to change the direction of expenditure from one item to another when there are gifts of nature. The consumer is unable to calculate utility of different commodities. The maximization of utility is not possible due to low income. The consumer is bound to use commodity. The law is used in the field of exchange. 7. Here the condition MU of apple = MU of banana i. 4. The law is applicable in public finance. The marginal utility of each dollar spent in one sector must be equal to marginal utility derived from all other sectors. $3 on apples and $3 on bananas. They do not care for maximum utility. There are certain lazy consumers. which provides low utility due to non availability of goods having high utility. The people like to exchange a commodity having low utility with a commodity having high utility. he can save more and spend less. 3. marriages and deaths. There is maximum benefit from exchange of commodities. He wishes to get maximum output and profit. He tries to equalize marginal utility of all factors. The people like to spend money on birthdays. The same information can be used for graphical presentation of this law: 7. The law of equi marginal utility is helpful in the field of production. The law is not applicable in case of indivisible goods. 2. 3. The total utility he can get is: [(10+9) + (8+7+6+5)] = 45. 4 . It does not work when there are frequent prices changes. $5 on apples and $1 on bananas. Different books provide variety of knowledge and satisfaction. 9. Total total utility for consumer is 49 utils that is the highest obtainable with expenditure of $4 on apples and $2 on bananas. It is not possible to express it into quantitative form. 8. $2 on apples and $4 on bananas. The law fails when goods of choice are not available. This way the total utility is: [(10+9+8+7) + (8+7)] = 49. He wants to spend this money on apples and bananas in such a way that there is maximum satisfaction to the consumer. 10. The total utility he can get is: [(10+9+8+7+6) + (8)] = 48. 3. The calculation of marginal utility of durable goods is impossible. 6. import and export. He uses limited resources to purchase production factors. They go on consuming goods with comparing utility. The law does not hold well in case fashion and customs. Limitations: 1. He can feel that a dollar saved has greater utility than a dollar spent. Changing price levels create confusion in the minds of consumers. He tries to equalize weighted marginal utility of all the things. It is psychological concept. 4. He will substitute one factor for another until marginal productivity of all factors is equal to prices of their services. The law fails to operate in case of laziness of consumers. $4 on apples and $2 on bananas. Importance: 1. 4. 5. The producer has limited resources.2.
point A gives as much utility as point B to the individual. The consumer will be satisfied at any point along the curve assuming that other things are constant. The above diagram shows the U indifference curve showing bundles of goods A and B. 5 . Due to scarcity of commodity its prices go up. which is less scarce. the indifference curve is drawn as a downward sloping convex to the origin. Indifference curve An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. In other words. The law is helpful in prices. Definition: An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. The result is that the price of commodity comes down. The graph shows a combination of two goods that the consumer consumes.spending till marginal utility of a dollar spent and a dollar saved are equal. bundle A and B are the same as both of them give him the equal satisfaction. 8. Description: Graphically. To the consumer. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. The law tells us to use substitute commodity.
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