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Theory of consumer behavior on the basis of Measurement of Utility

Cardinal Utility Theory of Consumer Behavior And Ordinal Utility Theory of Consumer Behavior 
Seeks to explain the decision making behaviour of the consumer in demanding a Particular commodity. Economists have offered theories on the basis of the measurement of utility.

Marshallian Cardinal Approach or Marginal Utility Approach or Marshallian Theory of Demand 1. Law of Equi Marginal Utility (Income and Substitution Effect) . Law of Diminishing Marginal Utility 3. Concept of Utility and its Cardinal 2.

‡ -ve slope = inverse relationship between P and D.UTILITY ANALYSIS OF DEMAND-MARSHALL ‡ Behaviour of a rational consumer with demand curve (Law of Demand). Demand . ‡ D curve is downward sloping towards right indicates consumer tends to buy more when P falls. D Price P2 P1 D Q1 Q2 Qt.

Additive U Constant MU of Money Diminishing Mu Rationality Introspective Analysis . Independent Utility.Basic Assumptions of MUA Cardinal utility-U is measurable.

‡ Utility is the satisfaction of consumer from consumption which can be measurable ( i.e. ‡ Law of Demand based on LMU.e.Law of Diminishing Marginal Utility and The Law of Demand ‡ Utility is the level of satisfaction from the product bought by the customer. . ‡ Marginal Utility (MU) is +nal U from +nal unit purchased. comparable ). be quantified ) and discernible ( i.

Law of Diminishing Marginal Utility and The Law of Demand ‡ From the observation of real life situation. the consumer tries to equalize MU of a commodity with its price so that his satisfaction is maximized and he will reach equilibrium point. the theory suggests that . ‡ the total utility of a consumer will increase through consumption. but for successive units of the goods consumed. no max of TU. ‡ Hence he¶ll decrease MU till = reduced Price.the marginal utility will gradually diminish ‡ According to the law. ‡ Increase in stock MU decreases. . MUx=Px ‡ When P falls. Consumer buys more when P falls. the additional or extra units of utility got . MU > than P-----No equilibrium .

To buy more chocolates. he has to give up ice cream and vice versa. 10. MU goes of chocolates goes on diminishing as he consumes more and more units. 10) MU per Rs on Chocol ates MU per Rs on Ice Cream Total Income limited to Rs. Chocolate and Ice cream both cost Rs. 10) Ice cream per Week (Rs. 60 per week. 1 2 3 4 5 5 4 3 2 1 10 8 6 4 2 2 4 6 8 10 .Marginal Utility of Chocolates and Ice Cream Chocola tes per Week (Rs.

‡ He is one of the many buyers in the sense that he is powerless to alter the market price. This utility is not only comparable but also quantifiable. This means that utility. ‡ The prices of all goods are given and known to a consumer.Assumptions ‡ The wants of a consumer remain unchanged. ‡ He acts rationally in the sense that he want maximum satisfaction ‡ Utility is measured cardinally. ‡ He has a fixed income. or use of a good. ‡ He can spend his income in small amounts. . can be expressed in terms of units or utils.

‡ The consumer will spend his money income on different goods in such a way that marginal utility of each good is proportional to its price. . ‡ The rationale is that as long as the marginal utility of any two or more goods are different. ‡ An extension to the law of DMU. ‡ This law states that how a consumer allocates his money income between various goods so as to obtain maximum satisfaction .The Law of Equi-Marginal Utility ‡ This law states that the consumer maximizing his total utility will allocate his income among various commodities in such a way that his marginal utility of the last rupee spent on each commodity is equal. a consumer will try to consume the good with a higher marginal utility.

MARGINAL UTILITY THEORY .

. Price of A = $1 .Quantity Good A TU MU Good B TU MU QA POSSIBILITIES QB T U of A & B 0 1 2 3 4 5 6 7 8 0 10 19 27 34 40 45 49 52 / 10 9 8 7 6 5 4 3 0 24 45 64 80 94 104 110 114 / 24 21 19 16 14 010 6 4 0 2 4 6 8 7 6 5 4 3 0 + 110 = 110 19 + 104 = 123 34 + 94 = 128 45 + 80 = 125 52 + 64 = 116 Result : M U of A / Price of A = M U of B / Price of B = 7 units of utility / $ 1 Given : Income = $14 . Price of B = $2.

then might be MUx/Px > MUy/Py. ‡ To attain equilibrium. ‡ This Price change is expressed by Marshall as Substitution Effect and Income Effect. ‡ Will substitute of X for Y till both MU and Price of X and Y are equal i.e. MUx/Px=MUy/Py i. consumer will reduce MUx and increase MUy till both ratios are equal. . MUx/Px = MUy/Py.e when the ratio of marginal utilities and price are equalized in purchasing the various commodities. ‡ If P of X falls.Explanation ‡ Consumer will be at equilibrium when. ‡ Will purchase more units of X and less of Y.

.  MUx / Px = MUy / Py = MUz / Pz .. the consumer will consume a different quantity of good X and Y.. ( The ratio of MU of any two goods =Their relative price ) ..... ( A state of consumer optimum )  If the equation is re-written into another form : MUx / MUy = Px / Py . spent ) derived from the good X & Y will equal so that a state of equilibrium could be reached.Concept of Utility and its Cardinal Condition of Consumer Optimum : Utility Maximization  From the example above..  The MU ( obtained by the last Rs.

‡ Since SE is always +ve. consumer is induced to substitute more of the relatively cheaper commodity for the dearer one (no change in price). ‡ Most common psychological attitude of every consumer. . at lower price. ‡ To increase his total satisfaction he purchased of the cheaper commodity.Substitution Effect ‡ When P decreased of a commodity. will buy large Qt.

if Qt. the consumer will demand more at reduced prices. purchasing power of the real income increases. . ‡ Therefore when Price decreases. consumer will increase purchase with fall in price. if entire surplus income is spent on some other comm. ‡ When a commodity has relatively high MU. ‡ Even if IE is -ve. ‡ If both SE and IE are +ve. can purchase more with the same money.Income Effect ‡ Refers to changes in real income of the consumer due to changes in price. purchased is less than before ( inferior good). ‡ IE can be +ve. -ve or Zero. D increases and vice versa. ‡ IE= -ve. ‡ IE= 0 . SE is relatively so forceful that it outweighs -ve IE. the IE will be +ve such that the surplus amount realized due to P decrease may be spent on the same commodity. ‡ When P decreases .

etc. Ex: TV sets. . Alfred Marshall accepts the cardinal approach. He further believes that the MU of money is constant. ‡ Consumer are ignorant and therefore are not in a position to arrive at an equilibrium.Limitations of Law of Equi-Marginal Utility ‡ It is difficult for the consumer to know the marginal utilities from different commodities because utility cannot be measured. Houses. ‡ It does not apply to indivisible and inexpensive commodity. This is a highly controversial assertion but it makes the analysis simpler.

‡ Incomplete Analysis of Price Effect ‡ Inadequate Explanation of Giffen Goods ‡ Limited Scope ‡ No empirical Test .Limitations of Marshallian Approach ‡ Untenable Cardinal measurement of Utility ‡ Wrong conception of +ve Utility ‡ Homogeneity Assumption is Unrealistic ‡ Separate measurement of Utility ‡ Constancy of MU of Money ‡ Inapplicability in case of Indivisible or bulky goods.