2. Introduction
Recall that the term ‘demand’ is defined as the quantity of a
commodity that a consumer is willing to buy at a given price
per unit of time.
So we are concerned with the questions:
How does the consumer decide how much of a commodity to
buy at a given price?
How does the consumer respond to change in the price of the
commodity, given his income, and prices of the related goods?
This questions take us to the theory of consumer behaviour.
The theory of consumer behaviour is based on an axiom that a
consumer is a utility maximizing entity.
2
3. Contd…
Why do you buy the goods and services you do?
It must be because they provide you with satisfaction—
you feel better off because you have purchased them.
Economists call this satisfaction utility.
The concept of utility is an elusive one. A person who
consumes a good such as peaches gains utility from
eating the peaches. But we cannot measure this utility
the same way we can measure a peach’s weight or
calorie content. There is no scale we can use to
determine the quantity of utility a peach generates.
3
4. Contd…
The demand for a commodity depends on the utility of
that commodity to a consumer.
If a consumer gets more utility from a commodity, he
would be willing to pay a higher price and vice-versa.
4
5. Nature of human wants
All desires, tastes and motives of human beings are
called want in Economics.
Wants arise due to elementary and psychological causes.
Since the resources are limited, we have to choose
between the urgent wants and the not so urgent wants.
Classification of wants- necessaries, comforts, and
luxuries.
5
6. Characteristics of human wants
Wants are unlimited
Every want is satiable
Wants are competitive
Wants are complimentary
Wants are alternative
Wants vary with time, place and person
Some wants recur again
Wants are influenced by advertisement
Wants become habits and customs
6
7. Utility
Utility is an economic term introduced by Daniel Bernoulli
referring to the total satisfaction received from consuming a
good or service.
It is the want satisfying power of a commodity.
It is a subjective entity and varies from person to person.
The economic utility of a good or service is important to
understand because it will directly influence the demand,
and therefore price, of that good or service.
7
8. Contd…
Utility hypothesis forms the basis of the theory of
consumer behaviour. From time to time, different theories
have been advanced to explain consumer behaviour and
thus to explain his demand for the product.
Two theories are-
(i) Marginal utility analysis by Marshall
(ii) Indifference curve analysis by Hicks and Allen.
8
9. Measurement of utility
The economists hold different views on whether utility is
measurable in absolute terms or not.
The classical and neo-classical economists held view that
utility is cardinally or quantitatively measurable: it can be
measured in cardinal numbers like weight, height, length,
temperature etc.
Modern economists, on the other hand, hold the view that
utility is not cardinally measureable. It can be measured in
ordinal terms- like less than, more than etc.
9
10. Definition of Cardinal Utility
The notion of Cardinal utility was formulated by Neo-classical
economists, who hold that utility is measurable and can be
expressed quantitatively or cardinally, i.e. 1, 2, 3, and so on.
The traditional economists developed the theory of
consumption based on cardinal measurement of utility, for
which they coined the term ‘Util‘ expands to Units of utility.
It is assumed that one util is equal to one unit of money, and
there is the constant utility of money.
Further, it has been realized with the passage of time that the
cardinal measurement of utility is not possible, thus less
realistic.
There are many difficulties in measuring utility numerically, as
the utility derived by the consumer from a good or service
depends on a number of factors such as mood, interest, taste,
preferences and much more.
10
11. Definition of Ordinal Utility
Ordinal Utility is propounded by the modern economists,
J.R. Hicks, and R.G.D. Allen, which states that it is not
possible for consumers to express the satisfaction
derived from a commodity in absolute or numerical terms.
Modern Economists hold that utility being a psychological
phenomenon, cannot be measured quantitatively,
theoretically and conceptually.
However, a person can introspectively express whether a
good or service provides more, less or equal satisfaction
when compared to one another.
In this way, the measurement of utility is ordinal, i.e.
qualitative, based on the ranking of preferences for
commodities.
For example: Suppose a person prefers tea to coffee
and coffee to milk. Hence, he or she can tell subjectively,
his/her preferences, i.e. tea > coffee > milk.
11
12. Measurement of Utility
Measuring utility in “utils” (Cardinal)
Jack derives 10 utils from having one slice of pizza but
only 5 utils from having a burger.
Measuring utility by comparison (Ordinal):
Jill prefers a burger to a slice of pizza and a slice of pizza
to a hotdog.
12
13. Cardinal Vs. Ordinal
Cardinal utility is the utility wherein the satisfaction
derived by the consumers from the consumption of good
or service can be measured numerically. Ordinal utility
states that the satisfaction which a consumer derives
from the consumption of product or service cannot be
measured numerically.
Cardinal utility measures the utility objectively, whereas
there is a subjective measurement of ordinal utility.
Cardinal utility is less realistic, as quantitative
measurement of utility is not possible. On the other end,
the ordinal utility is more realistic as it relies on qualitative
measurement.
Cardinal utility, is based on marginal utility analysis. As
against this, the concept of ordinal utility is based on
indifference curve analysis.
13
14. Contd…
The cardinal utility is measured in terms of utils, i.e. units
of utility. On the contrary, the ordinal utility is measured in
terms of ranking of preferences of a commodity when
compared to each other.
Cardinal utility approach propounded by Alfred Marshall
and his followers. Conversely, ordinal utility approach
pioneered by Hicks and Allen.
14
15. Marginal utility analysis
This theory seeks to explain how a consumer spends his
income on different goods and services so as to attain
maximum satisfaction.
Total utility: The total satisfaction from a given level of
consumption. In other words, it is the total utility derived
from different units of a commodity consumed by a
consumer.
Marginal utility: The change in satisfaction from
consuming an extra unit
Standard economic theory believes in the idea of
diminishing returns i.e. the marginal utility of extra units
declines as more is consumed
15
16. Law of Diminishing Marginal Utility
It states that with the increased consumption of the
commodity, the satisfaction derived from each successive
unit goes on diminishing.
16
17. Assumptions
It is assumed that the unit of the consumer good is a
standard one, i.e. the rational quantity of the commodity
is consumed. Such as, a cup of tea, a pair of shoes,
bottle of cold drink, glass of water, etc.
It is assumed that the utility is measurable, and the
satisfaction of the consumers can be expressed in
the quantitative terms.
The consumer’s tastes and preferences remain same
during the period of the consumption.
There must be continuity in the consumption. If a
break is necessary, then the time interval between the
consumption of two units should be appropriately short.
It is assumed that the quality of the commodity
remains uniform during the period of consumption.
17
18. Contd…
All the commodities consumed by the consumer are said
to be independent of each other, such as the marginal
utility of one commodity has no relation with the marginal
utility of another commodity.
It is assumed that the income of the consumer and
the price of goods and services remains unchanged
during the period of consumption.
The marginal utility of money remains constant for the
consumer.
18
19. Example to Demonstrate Law of Diminishing
Marginal Utility
Units of
orange
Total utiity Marginal
utility
1 12 12
2 22 10
3 30 8
4 36 6
5 40 4
6 41 0
7 39 -2
8 34 -5
19
23. Relationship between MU an TU
From the graph we can conclude that:
i. When total utility rises, the marginal utility diminishes
ii. When total utility is maximum, the marginal utility is
zero
iii. When total utility is diminishing, the marginal utility is
negative.
23
24. Limitations
Homogenous units
Standard unit of consumption
Continuous consumption
The fails in the case of prestigious goods
Case of related goods
24
25. Consumer Surplus
The concept of consumer’s surplus was evolved by Alfred
Marshall. This concept occupies an important place not
only in economic theory but also in economic policies of
government and in decision-making of monopolists.
It has been seen that consumers generally are ready to
pay more for certain goods than what they actually pay
for them. This extra satisfaction which consumers get
from their purchase of goods is called consumer surplus.
Consumer surplus is a measure of the welfare that
people gain from consuming goods and services
Consumer surplus= What a consumer is ready to pay
-
What he actually pays
25
27. Indifference Curve
In microeconomics, indifference curve is an important
tool of analysis in the study of consumer behavior.
The concept of indifference curve analysis was first
propounded by British economist Francis Ysidro
Edgeworth and was put into use by Italian economist
Vilfredo Pareto during the early 20th century. However, it
was brought into extensive use by economists J.R. Hicks
and R.G.D Allen.
Hicks and Allen criticized Marshallian cardinal approach
of utility and developed indifference curve theory of
consumer’s demand. Thus, this theory is also known as
ordinal approach.
27
28. Meaning
An indifference curve is a locus of all combinations of two
goods which yield the same level of satisfaction (utility) to
the consumers.
Since any combination of the two goods on an
indifference curve gives equal level of satisfaction, the
consumer is indifferent to any combination he consumes.
Thus, an indifference curve is also known as ‘equal
satisfaction curve’ or ‘iso-utility curve’.
On a graph, an indifference curve is a link between the
combinations of quantities which the consumer regards
to yield equal utility. Simply, an indifference curve is a
graphical representation of indifference schedule.
28
31. Assumptions
Two commodities: It is assumed that the consumer has
fixed amount of money, all of which is to be spent only on
two goods. It is also assumed that prices of both the
commodities are constant.
Non satiety: Satiety means saturation. And, indifference
curve theory assumes that the consumer has not
reached the point of satiety. It implies that the consumer
still has the willingness to consume more of both the
goods. The consumer always tends to move to a higher
indifference curve seeking for higher satisfaction.
Ordinal utility: According to this theory, utility is a
psychological phenomenon and thus it is unquantifiable.
However, the theory assumes that a consumer can
express utility in terms of rank. Consumer can rank
his/her preferences on the basis of satisfaction yielded
from each combination of goods.
31
32. Contd…
Diminishing marginal rate of substitution: Marginal rate of
substitution may be defined as the amount of a commodity
that a consumer is willing to trade off for another commodity,
as long as the second commodity provides same level of utility
as the first one.
And, diminishing marginal rate of substitution states that the
rate by which a person substitutes X for Y diminishes more
and more with each successive substitution of X for Y.
As indifference curve theory is based on the concept of
diminishing marginal rate of substitution, an indifference curve
is convex to the origin.
Rational consumers: According to this theory, a consumer
always behaves in a rational manner, i.e. a consumer always
aims to maximize his total satisfaction or total utility.
32
33. Properties of indifference curve
Indifference curve slope downwards to right: An
indifference curve can neither be horizontal line nor an
upward sloping curve. This is an important feature of an
indifference curve.
When a consumer wants to have more of a commodity,
he/she will have to give up some of the other commodity,
given that the consumer remains on the same level of
utility at constant income. As a result, the indifference
curve slopes downward from left to right.
33
34. Contd…
In the diagram, IC is an
indifference curve, and A and B
are two points which represent
combination of goods yielding
same level of satisfaction.
We can see that when X1
amount of commodity X was
consumed, Y1 amount of
commodity Y was also
consumed. When the consumer
increased the consumption of
commodity X1 to X2, the
amount of commodity Y1 fell to
Y2. And, thus the curve is
sloping downward from left to
right.
34
35. Contd…
Indifference curve is convex to the origin: As mentioned
previously, the concept of indifference curve is based on
the properties of diminishing marginal rate of substitution.
According to diminishing marginal rate of substitution, the
rate of substitution of commodity X for Y decreases more
and more with each successive substitution of X for Y.
Also, two goods can never perfectly substitute each
other. Therefore, the rate of decrease in a commodity
cannot be equal to the rate of increase in another
commodity.
35
36. Contd…
Combination Cigarette Coffee
A 1 12
B 2 8
C 3 5
D 4 3
E 5 2
The table represents various
combination of coffee and
cigarette that gives a man
same level of utility.
When the man drinks 12 cup
of coffee, he consumes 1
cigarette every day.
When he started consuming
two cigarettes a day, his
coffee consumption dropped
to 8 cups a day.
In the same way, we can
see other combinations as 3
cigarettes + 5 cup coffee, 4
cigarettes + 3 cup coffee
and 5 cigarettes + 2 cup
coffee.
36
37. Contd…
We can clearly see that the
rate of decrease in
consumption of coffee is not
the same as rate of increase
in consumption of cigarette.
Similarly, rate of decrease in
consumption of coffee has
gradually decreased even
with constant increase in
consumption of cigarette.
Thus, indifference curve is
always convex (neither
concave nor straight).
37
38. Contd…
Indifference curve cannot intersect each other: Each
indifference curve is a representation of particular level of
satisfaction.
The level of satisfaction of consumer for any given
combination of two commodities is same for a consumer
throughout the curve. Thus, indifference curves cannot
intersect each other.
38
39. Contd…
In the fig., IC1 and IC2 are two
indifference curves and C is the
point where both the curves
intersect.
According to indifference curve
theory, satisfaction at point C =
satisfaction at point A
Also, satisfaction at point C =
satisfaction at point B
But, satisfaction at point B ≠
satisfaction at point A.
Therefore, two indifference
curves cannot intersect. Yet,
two indifference curves need
not be parallel to each other.
39
40. Contd…
Higher indifference curve represents higher level of
satisfaction:
Higher the indifference curves, higher will be the level of
satisfaction. This means, any combination of two goods
on the higher curve give higher level of satisfaction to the
consumer than the combination of goods on the lower
curve.
40
41. Contd…
In the above figure, IC1 and
IC2 are two indifference curves,
and IC2 is higher than IC1. We
can also see that Q is a point
on IC2 and S is a point on IC2.
Combination at point Q
contains more of both the
goods (X and Y) than that of
the combination at point S.
We know that total utility of
commodity tends to increase
with increase in stock of the
commodity.
Thus, utility at point Q is greater
than utility at point S, i.e.
satisfaction yielded from higher
curve is greater than
satisfaction yielded from lower
curve.
41
42. Consumer Budget
Let us consider a consumer who has only a fixed amount
of money (income) to spend on two goods the prices of
which are given in the market.
The consumer cannot buy any and every combination of
the two goods that he/she may want to consume.
The consumption bundles that are available to the
consumer depend on the prices of the two goods and the
income of the consumer.
Given his/her fixed income and the prices of the two
goods, the consumer can afford to buy only those
bundles which cost him/her less than or equal to her
income.
42
43. Budget Line
Budget line is a graphical representation which shows all
the possible combinations of the two goods that a
consumer can buy with the given income and prices of
commodities. It is also called consumption possibility line.
Suppose, a consumer has Rs. 600 as his money income
and decides to spend this entire income on the purchase
of two commodities X1 and X2 where per unit price of
X1 be Rs. 5 and that of X2 Rs.4 per unit and these prices
remain unchanged during the period in which the
consumer buys these commodities.
If the consumer decides to spend his entire money
income of Rs. 600 on the purchase of commodity X1, he
can buy 120 units of X, and on purchase of X2 i. e., 150
units of X2 (shown in given figure as point R and P).
43
44. Contd…
Points P and R are two extreme
possibilities of the combination
of that the can purchase with
his given money income and
prices of commodities.
By joining points P and R, we
can know all the possible
combinations of two
commodities X1
and X2, which can be
purchased with Rs.600.
We, therefore get the budget
line RP. It is also called Price
income line.
Thus, the budget line is the set
of bundles that costs exactly M.
44
45. Optimal choice of goods for consumer
Given a budget line of B1, the
consumer will maximise utility
where the highest indifference
curve is tangential to the
budget line (20 apples, 10
bananas)
Given current income – IC2 is
unobtainable.
IC3 is obtainable but gives less
utility than the higher IC1
The optimal choice of goods
can also be shown with
the Equi-marginal principle.
45
46. Income effect
In the analysis of the consumer’s equilibrium it was
assumed that the income of the consumer remains
constant, given the prices of the goods X and Y.
Given the tastes and preferences of the consumer and
the prices of the two goods, if the income of the
consumer changes, the effect it will have on his
purchases is known as the income effect.
If the income of the consumer increases his budget line
will shift upward to the right, parallel to the original budget
line.
On the contrary, a fall in his income will shift the budget
line inward to the left. The budget lines are parallel to
each other because relative prices remain unchanged.
46
47. Contd…
In Figure when the budget line is
PQ, the equilibrium point is R
where it touches the indifference
curve I1.
If now the income of the consumer
increases, PQ will move to the
right as the budget line P1Q1, and
the new equilibrium point is S
where it touches the indifference
curve I2. As income increases
further, PQ becomes the budget
line with T as its equilibrium point.
The locus of these equilibrium
points R, S and T traces out a
curve which is called the income-
consumption curve (ICC).
47
48. Contd…
The ICC curve shows the income effect of changes in consumer’s
income on the purchases of the two goods, given their relative
prices.
Normally, when the income of the consumer increases, he purchases
larger quantities of two goods. In Figure he buys RA of Y and OA of
X at the equilibrium point R on the budget line PQ. As his income
increases, he buys SB of Y and OB of X at the equilibrium point S on
P1Q1, budget line and still more of the two goods TC of Y and ОС of
X, on the budget line P2Q2. Usually, the income consumption curve
slopes upwards to the right as shown in Figure.
But an income-consumption curve can have any shape provided it
does not intersect an indifference curve more than once. We can
have five types of income consumption curves. The first type is
explained above in Figure where the ICC curve has a positive slope
throughout its range. Here the income effect is also positive and both
X and Y are normal goods.
48
49. The Price Effect
Examines the effects of change in price on consumer
behaviour when income remains constant.
When price of commodity changes, the slope of the
budget line changes, which changes the condition for
consumer’s equilibrium.
A rational consumer adjusts his consumption basket with
a view to maximizing his satisfaction under the new price
conditions. This change in consumption basket is called
price-effect.
The price effect indicates the way the consumer’s
purchases of good X change, when its price changes, A
given his income, tastes and preferences and the price of
good Y.
49
50. Contd…
Suppose the price of X
falls. The budget line PQ
will extend further out to
the right as PQ1, showing
that the consumer will buy
more X than before as X
has become cheaper.
The budget line
PQ2 shows a further fall in
the price of X.
Any rise in the price of X
will be represented by the
budget line being drawn
inward to the left of the
original budget line
towards the origin.
50
51. The Substitution Effect
The substitution effect relates to the change in the
quantity demanded resulting from a change in the price
of good due to the substitution of relatively cheaper good
for a dearer one, while keeping the price of the other
good and real income and tastes of the consumer as
constant.
Prof. Hicks has explained the substitution effect
independent of the income effect through compensating
variation in income.
“The substitution effect is the increase in the quantity
bought as the price of the commodity falls, after adjusting
income so as to keep the real purchasing power of the
consumer the same as before. This adjustment in income
is called compensating variations and is shown
graphically by a parallel shift of the new budget line until
it become tangent to the initial indifference curve.”
51
52. Contd…
Thus on the basis of the methods of compensating variation,
the substitution effect measure the effect of change in the
relative price of a good with real income constant.
The increase in the real income of the consumer as a result of
fall in the price of, say good X, is so withdrawn that he is
neither better off nor worse off than before.
The substitution effect is explained in Figure where the original
budget line is PQ with equilibrium at point R on the
indifference curve I1.
At R, the consumer is buying OB of X and BR of Y. Suppose
the price of X falls so that his new budget line is PQ1. With the
fall in the price of X, the real income of the consumer
increases.
To make the compensating variation in income or to keep the
consumer’s real income constant, take away the increase in
his income equal to PM of good Y or Q1N of good X so that his
budget line PQ1 shifts to the left as MN and is parallel to it.
52
53. Contd…
At the same time, MN is
tangent to the original
indifference curve l1 but at point
H where the consumer buys
OD of X and DH of Y.
Thus PM of Y or Q1N of X
represents the compensating
variation in income, as shown
by the line MN being tangent to
the curve I1 at point H.
Now the consumer substitutes
X for Y and moves from point R
to H or the horizontal distance
from В to D.
This movement is called the
substitution effect.
53
54. Contd…
The substitution affect is always negative because when
the price of a good falls (or rises), more (or less) of it
would be purchased, the real income of the consumer
and price of the other good remaining constant. In other
words, the relation between price and quantity demanded
being inverse, the substitution effect is negative.
54
55. Separation of Substitution and Income
Effects from the Price Effect
55
The Hicksian Method:
Hicks has separated the substitution effect and the
income effect from the price effect through compensating
variation in income by changing the relative price of a
good while keeping the real income of the consumer
constant.
Suppose initially the consumer is in equilibrium at point R
on the budget line PQ where the indifference curve I1, is
tangent to it at point R in Figure 32. Let the price of good
X fall. As a result, his budget line rotates outward to PQ1,
where the consumer is in equilibrium at point T on the
higher indifference curve I2 .
56. Contd…
56
The movement from R to T or В to E
on the horizontal axis is the price
effect of the fall in the price of X. With
the fall in the price of X, the
consumer’s real income increases.
To make the compensating variation
in income in order to isolate the
substitution effect, the consumer’s
money income is reduced equivalent
to PM of Y or Q1N of X by drawing the
budget line MN parallel to PQ1, so that
it is tangent to the original indifference
curve I1 at point H.
The movement from the R to H on the
I1, curve is the substitution effect
whereby the consumer increases his
purchases of X from В to D on the
horizontal axis by substituting X for Y
because it is cheaper.
57. Contd…
57
It may be noted that when there is a fall (or rise) in the
price of good X, the substitution effect always leads to an
increase (or decrease) in its quantity demanded. Thus
the relation between price and quantity demanded being
inverse, the substitution effect of a price change is
always negative, real income being held constant.
To isolate the income effect from the price effect, return
the income which was taken away from the consumer so
that he goes back to the budget line PQ1, and is again in
equilibrium at point T on the curve The movement from
point H on the lower indifference curve I1, to point T on
the high indifference curve I2 is the income effect of the
fall in the price of good X. By the method of
compensating variation in income, the real income of the
consumer has increased as a result of the fall in the price
of X.
58. Contd…
58
The consumer purchases more of this cheaper good X
thus moving on the horizontal axis from D to E. This is
the income effect of the fall in the price of a normal good
X. The income effect with respect to the price change for
a normal good is negative. In the above case, the fall in
the price of good X has increased the quantity demanded
by DE via the increase in the real income of the
consumer.
Thus the negative income effect DE of the fall in the price
of good X strengthens the negative substitution effect BD
for the normal good so that the total price effect BE is
also negative, that is, a fall in the price of good X has led,
on both counts, to the increase in its quantity demanded
by BE.
59. Derivation of individual demand curve
A demand curve has been defined as a curve that shows a
relationship between the quantity-demanded of a commodity
and its price assuming income, the tastes and preferences of
the consumer and the prices of all other goods constant.
To draw an individual demand curve the information regarding
prices of a commodity at different levels and their
corresponding quantities demanded is required. The price-
consumption curve can provide this information.
Fig. illustrates the way in which the individual demand curve
can be derived from the price consumption curve. When a
demand curve is to be drawn, units of money are measured on
the vertical axis while the quantity of a commodity for which
demand curve is to be drawn are shown on the horizontal axis.
59
60. Contd…
Suppose a consumer has an income of
Rs.240.
If the price of the commodity X is Rs.60
per unit, the relevant price line will be
LM1, because at this 2 units can be
purchased. The consumer is in
equilibrium at point e1 where the
consumer buys 2 units of the commodity.
Suppose the price of X falls to Rs.40 per
unit. The price line shifts to LM2. The
consumer attains a new equilibrium point
e2 and buys 3 units of X.
As the price of X further falls, the budget
line shifts to the right and new successive
points of equilibrium are attained where
the consumer is in equilibrium at e3 and
e4 and buys 5 and 7 units of commodity X
when the price is Rs.30 and Rs.24 per
unit respectively.
60
61. Contd…
With the above information, we draw up the following
demand schedule of the consumers.
61
63. How Indifference Curve Analysis is Superior
over Utility Analysis?
1. It Dispenses with Cardinal Measurement of Utility:
The entire utility analysis assumes that utility is a
cardinally measurable quantity which can be assigned
weights called ‘Utils’.
If the utility of an apple in 10 utils of a banana it is 20
utils, and of a cherry 40 utils, then the utility of a banana
is twice that of an apple and of cherry four times that of
apple and twice that of banana. This is not
measurability but transitivity.
In fact, the utility which a commodity possesses for a
consumer is something subjective and psychological
and therefore cannot be measured quantitatively. The
indifference approach is superior to the utility analysis
because it measures utility ordinarily.
63
64. Contd…
2. It studies combination of two goods instead of one
good:
The utility approach a single commodity analysis in which
the utility of one commodity is regarded independent of
the other. Marshall avoided the discussion of substitutes
and complementary goods by grouping them together as
one commodity.
While the Indifference Curve technique is a two-
commodity model which discusses consumer behaviour
in the case of substitutes complementary and unrelated
goods. It is thus superior to the utility analysis.
64
65. Contd…
3. It provides a better classification of goods into
substitutes and complements:
Early days economists explained substitutes and
complements in terms of cross elasticity of demand. Prof.
Hicks considers this inadequate and explains them after
making compensating variations in income. He thus
overcomes the ambiguity to be found in the traditional
classification of substitutes and complements.
4. It is free from the assumption of constant marginal
utility of money:
The Utility analysis assumes constant marginal utility of
money. Marshall justifies it on the plea that an individual
consumer spends only a small part of his whole expenditure
on any one thing at a time. This assumption makes the utility
theory unrealistic in more than one way. On the other-hand,
the Indifference Curve technique analyses the income effect
when the income of the consumer changes.
65
66. Contd…
5. It explains the law of diminishing marginal utility
without the unrealistic assumptions of the utility
analysis:
The utility analysis postulates the Law of Diminishing
Marginal Utility which is applicable to all types of goods
including money. But this law is based on the cardinal
measurement, it possesses all the defects inherent in the
latter.
Prof. Hicks says that it is a positive change and it is
scientific and at the same time, free from the
psychological quantitative measurement of the utility
analysis. The application of this principle in the fields of
consumption, production and distribution has made
economics more realistic.
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67. Contd…
6. It explains the dual effects of the price effect:
Utility analysis fails to analyze the income and substitution
effects of a price change. In the indifference curve technique
when the price of a good falls, the real income of the
consumer increases. This is the income effect.
Further, when the price falls, the goods become cheaper. This
Indifference Curve technique is definitely superior to the utility
analysis because it discusses the income effect when the
consumer’s income changes, the price effect when the price of
a particular goods changes and its dual effect in the form of
the income and substitution effect.
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68. Contd…
7. It explains the proportionality rule in a better way:
The Indifference Curve technique explains consumer’s
equilibrium in a similar but in a better way than the Marshallian
proportionality rule. The consumer is in equilibrium at a point
where his budget line is tangent to the Indifference Curve. At
this point the slope of the Indifference Curve equals the budget
line.
8. It explains the law of demand more realistically:
The Indifference Curve technique explains the Law of Demand
in a more realistic manner. It explains the effect of the fall in
the price of an inferior goods on consumer’s demand. Giffen
goods which remained a paradox for Marshall through-out,
have been ably explained with the help of this technique.
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