THEORY OF CONSUMER

DEMAND
APPROACHES TO DEMAND ANALYSIS
APPROACHES TO DEMAND

1.Ordinal approach to the theory of demand

2.Cardinal Approach to the theory of demand
THE CARDINAL UTILITY THEORY

• This theory is also called

• 1. Utility theory
• 2. Cardinal Utility Theory
• 3. Marginal Approach Theory
• 4. The Classical Approach to demand theory
UTILITY

• The term “utility” was first introduced by the British

philosopher Jeremy Bentham (1748-1832)
• Later published by Adam Smith (1732-90)
• And again by Karl Marx 1818-83
THE UTILITY PRINCIPLE IN THE EARLY 1700’S

• The utility principle is defined to be

• “property OR an object….to produce pleasure,
good or happiness or prevent…pain evil or
unhappiness”
SO WHAT EXACTLY IS “UTILITY”

The characteristics of a commodity or service to satisfy a human want. The amount of

satisfaction a person derives from some commodity or service, is called utility.
So, in other words the satisfaction is another for utility
WHAT EXACTLY IS THE CARDINAL THEORY

According to this approach, the utility is measurable and can be expressed in

quantitative terms. ( USING CARDINAL NUMBERS)
 This theory believes that in the real world, consumers seeks to maximize their
welfare, subject to their constraints ( INCOME,PRICE OF THE COMMODITY),
imposed by their income and the market prices of goods and services.
CARDINAL THEORY

• Derives it name because this theory believes that satisfaction is measurable using cardinal numbers
• What are cardinal number
• 1,2,3,4,5,6,7,
• So it is believed that utility OR SATISFACTION is measurable or can be ranked
UTILITY

• Goods and services are demanded because they provide satisfaction to consumers.

• Satisfaction in economics is called utility

ASSUMPTIONS OF THE THEORY

1. INCOMES ARE FIXED

2. PRICES OF RELATED GOODS ARE UNCHANGED
3. TASTES ARE UNCHANGED
4. THE CONSUMER IS RATIONAL
5. CONSUMERS SEEK TO MAXIMISE SATISFACTION OR UTILITY
UTILITY

• Utility is therefore defined as the MAIN determinant of demand

according to the Marginal Approach ALSO CALLED THE
CARDINALIST THEORY
• Utility can also be regarded as consumer welfare.
• In other words, a consumer will only purchase a commodity if it
offers him utility /satisfaction.
MARGINAL APPROACH THEORY
TYPES OF UTILITY

• 1.
• Marginal Utility (MU)
• 2. Total Utility (TU)
•
MARGINAL APPROACH

• Consumers have 2 major decision making tasks when confronting the market
• A) which goods to buy
• B) What quantities of these goods to buy
HOW DO WE MEASURE UTILITY:

• Traditionally, the unit of measurement for utility was the util.

• However, in modern economics: 1 util is equated to $1 and therefore utility is
measured in monetary terms.
• Example 20 utils = $20
• 10 utils =$10
UTILITY AND CONSUMPTION

• The utility that a consumer receives from consuming successive units of a

commodity decreases as more of that commodity is consumed.
EXAMPLE
KEY CONCEPTS RELATED TO THE CARDINAL
THEORY

• Total utility (TU)

• Marginal Utility (MU)
• The law of diminishing marginal utility
WHAT IS TOTAL UTILITY

• The total or complete amount of satisfaction a person derives from some

commodity or service over a period of time, is called total utility. In other
words, it is the sum of marginal utilities obtained from consumption of each
successive unit of a commodity or service.
• In other words, the total utility that a consumer derives from consuming a
good is equitable to the total satisfaction the consumer receives.
HOW DO WE CALCULATE TOTAL UTILITY (TU)

• Equation : TUx = ∑ Mux

• TU= TOTAL UTILITY
• X= OF X MEANING THE PARTICULAR GOOD OR SERVICE
• MU= MARGINAL UTILITY
• In other words it is the summation ( Ʃ ) of the marginal
utility of good x (MU) of x
TOTAL UTILITY

• The cumulative sum of marginal utility gives the total utility of the consumer for consuming a
commodity.
MARGINAL UTILITY (MU)

• Marginal utility refers to the satisfaction a consumer receives from consuming

an EXTRA UNIT of the commodity.
• 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.
HOW DO WE CALCULATE 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
SIMPLIFIED
: MARGINAL UTILITY

• If consumers realizes a total utility of TU n from consuming n units of a commodity and TU n-I from
consuming n-1 units of the commodity, then we derive the marginal utility (MU) from consuming nth
unit of a commodity as:
• MU nth = TUn –TU n-1
• It must be noted that as more and more of a commodity is consumed the marginal utility
derived becomes less and less
THE LAW OF DIMINISHING MARGINAL
UTILITY

• The law states

• That s increasing amounts of a commodity are consumed the marginal utility of the additional unit
consumed diminishes.
GRAPHICAL REPRESENTATION

• Of total utility and marginal utility

HOW DOES THE LAW OF DIMINISHING
MARGINAL UTILITY EXPLAIN THE FIRST
LAW OF DEMAND

• Condition for equilibrium :

• Satisfaction is equal to the money paid for the commodity (money given up)
• Equilibrium is simply defined as a balance between 2 forces that is satisfaction = money paid
• Expressed in another way marginal utility equals price
• P=MU