THE CARDINAL UTILITY THEORY

• Introduction
• Assumptions
• Equilibrium of the Consumer
• Derivation of the demand curve
• Limitations
 Introduction
• Demand refers to a desire for a good backed by ability and
willingness to pay. It refers to the quantity demanded for goods and
services at different prices in given period.

• In other words, it is the quantity of a commodity that a person is

willing to buy at a given price in a specified period of time

• Demand is a multivariate relationship. It is determined by many

factors simultaneously: its own price, consumers income, price of
other commodities, tastes, income distribution, total population ,
consumers wealth, credit availability, Govt. policy, past levels of
demand & fast levels of income, advertisement, etc.

• The traditional theory of demand has concentrated on four of the

above determinants (price, income, price of other goods and taste
Approaches to behavior of consumer
• A) The Cardinalist approach ; B) Ordinalist approach

• A). The cardinalist school postulated that utility can be

measured. Some economists suggested that utility can be
measured in monetary units by the amount of money the
consumer is willing to sacrifice for another unit of commodity

• Others suggested the measurement of utility in subjective units

called utils by Walras

• B).The ordinalist school postulated that utility is not measurable;

it is on ordinal magnitudes. The consumer need not know utility
of various commodities in specific units to make his choice.

• It is sufficient for him if he is able to rank the various baskets of

goods according to the satisfaction that each bundle gives him.
 Assumptions

1) Rationality: The consumer is assumed to be rational.

2) Cardinal utility: The utility of each commodity is measurable in

terms of money. The utility is measured by the monetary units
that the consumer is prepared to pay for another unit of the
commodity.

3) Constant marginal utility of money : If the marginal utility of

money changes as income increases or decreases, the measuring
rod for utility becomes like an elastic ruler; then it becomes in
appropriate for measurement of utility.

4) Diminishing marginal utility: The utility obtained from

successive units of a commodity diminishes. Hermann Heinrich
Gossen was the first to formulate this law in 1854 it is known as
the “Gossen’s first law”.
5) Additivity:The total utility of a basket of goods depends on
the quantities of the individual commodity. If there are ‘n’
commodities in the bundle with quantities X1, X2…….Xn,
U=f (X1, X2………..Xn)

In the early version of the demand theory or theory of

consumer behavior it was assumed that the total utility is
additive.
U= U1 (X1) +U2 (X2)…..+Un (Xn)

But the additivity assumption was dropped in the later

version of the cardinalist approach

Additivity implies that independent utilities of the various

commodities in the bundle, an assumption clearly unrealistic
and not necessary for the cardinal theory.
 Equilibrium of the Consumer
Condition for the equilibrium
MUx = Px
If MUx > Px, the consumer can increase welfare
by purchasing more of x commodities
If MUx < Px, the consumer can increase his total
satisfaction by cutting down his purchase of x commodities
If MUx = Px, the consumer will be in equilibrium

If there are two commodities

MUx/Px = MUy/Py
The utility that can be derived from spending an additional unit
of money must be the same for all commodities he consumes.
This is known as the “Law of Equi-margina Utility”, termed it
as Gossen’s second law.
Derivation of Demand Curve according to Cardinal approach

Fig:1 Derivation of Demand Curve

Ux MUx

TU

X O X
O X X Quantity of X
Quantity of X MUx
Fig: Marginal Utility Curve and Derivation of Demand Curve

MUX Px

MU1 P1

MU2 P2

MU3 P3

O O X3
X1 X2 X3 X1 X2
MUX Quantity of X
 Why does demand curve slopes downward?

1) Income effect of price change

2) Substitution effect
3) Price effect
4) Diminishing marginal utiltity
 Weakness of Cardinal approach
1) The assumption of cardinal utility is extremely
doubtful. The satisfaction derived from the
consumption of various goods cannot be measured
objectively. The attempts by Walras to use subjective
units (utils) for the measurement of utility does not
provide any solution.
2) The assumption of constant marginal utility is
unrealistic. As income increases, the marginal utility of
money changes.
3) The law of diminishing marginal utility has been
established from introspection. It is a psychological
law which must be taken for granted,
 Exception to the law of demand

• Bandwagon effect: People sometimes demand a commodity

because other are purchasing, either to be fashionable or to
keep up with others. Demand curve will be flatter or more
elastic

• Snob effect: As the price of a commodity falls, more people

buy it; but some people stop buying it in order to stand out to
be different.

• Veblen effect: In order to impress others,some individuals

demand more of certain commodities such as diamond, mink
coats which are more expensive.
Table 1: Marginal Utility of Good X and Y
Units MUx MUy MUx/Px MUy/Py
(Units) (Units)
1 20 24 10 8
2 18 21 9 7
3 16 18 8 6
4 14 15 7 5
5 12 12 6 4
6 10 9 5 3

Income Rs 24 6 units of X
Price of x Rs.2 4 units of Y
Price of y Rs.3
MUx/Px = MUy/Py= 10/2 = 15/3=5