1
Cardinal Utility Approach
What is utility?
• A want satisfying capacity of a commodity
or service.
• Utility is found in...
2
Concept of Total
Utility
TU is a function of the
quantity of the commodity
consumed.
MU is the utility of an
additional ...
3
Cardinal Utility Assumptions
• Utility is Quantifiable entity.
• Utility is both measurable and
additive.
• Utility is i...
4
• Assumption of Rationally.
• Fixed Income and Price.
• Stability of tastes (Short
Run Theory)
• Assumption of divisibil...
5
Law of Diminishing Marginal
Utility
“ As a consumer increases the
consumption of any one
commodity, keeping constant of
...
6
Assumptions of Law
• Utility can be measured in
cardinal numbers.
• All other things remain constant-
income etc (Fashio...
7
Causes of its operations
• Wants are unlimited and can not
be satisfied but want for a
commodity can be fully satisfied....
8
Exceptions to the law
• Misers, Drunkards, size of initial
units, love of power and display,
rare and curious things
Con...
9
Importance of law
• Bases of Equi-Marginal
utility.
• and law of demand.
• Helps in price determination.
• Basis of soci...
10
Equi-Marginal Principle
An input should be so allocated
that the value added by the last
unit is the same in all cases....
11
Similarly, a producer
seeking maximum profit
would use that technique of
production or input-mix
which would ensure
MRP...
12
Law of Equi-Marginal
Utility
“The household maximizing
utility will so allocate its
expenditure between
commodities in ...
13
Importance of law of Equi
M utility
Consumption- To get maximum
satisfaction.
Production – Earn maximum profits.
Exchan...
14
Public Finance – Taxes are levied
in a manner that the marginal
sacrifice of each tax payer is equal.
Similarly, the ma...
15
Determinants of consumer
Equilibrium
• Single commodity with single use:
Mu=P
What happens if Mu>P or Mu<P?
When commod...
16
Single commodity
several uses
Mua = Mub = Muc andso on.
Several commodities with same
price = Mux = Muy = Muz
Several c...
17
Law of Diminishing Marginal
Rate of Substitution
“The MRS of x for y is the amount
of y the consumer is just willing to...
18
Why MRs Diminishes?
The law of DMRS is an extension of
law of diminishing marginal utility.
Fundamental Assumptions
Rat...
19
Substitution Effect
Given a constant income of the consumer, a
change in the relative price of the two
commodities may ...
20
Substitutions Effect
Substitution effect refers to
the change in the
consumption or demand for
two goods as a result of...
21
Assumptions of Hicksian
Substitution Effect
• Money income of the
consumer remains the same
• The relative prices of tw...
22
• The Cheapness of one
commodity and expensiveness
of the other cancel each other
by compensating variation
technique a...
23
Ordinal Utility Approach
Ordinal utility technique is based
upon the comparablities of utilities
and avoids quantificat...
24
Ordinal utility asks, “Is ‘A’
preferred to ‘B’. This does not
require that we know how much ‘A’
is preferred to B.
What...
25
Properties of indifference
curve
• Indifference curve slopes
downwards from left to right.
• Convex to the origin.
• In...
26
Price Line or Budget Line
The Budget line or price line shows all
the different combinations of two
goods that a consum...
27
Indifference Map
A set of indifference curves is a
indifference map. In
indifference map all
combinations on one
indiff...
28
Conditions of Consumer
Equilibrium
• The Price line should be
tangent to IC.
• IC should be convex to the
point of orig...
29
Price Effect as Combination of
Income & Substitution Effect
• Income Effect: Effect on the
purchase of the consumer cau...
30
Price Effect
The price effect shows how much
the satisfaction of the consumer
varies due to the change in the
consumpti...
31
Price effect = Movement
from E to E1
Substitution effect =
Movement from E to E2
Income Effect = Movement
from E2 to E1...
32
Consumer Surplus
The difference between what a
consumer is willing to pay and
what he actually pays is called
consumer ...
Consumer surplus
• The money value of consumer surplus
• can be measured as the area under the
demand curve but above the ...
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Consumer behaviour

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Consumer behaviour

  1. 1. 1 Cardinal Utility Approach What is utility? • A want satisfying capacity of a commodity or service. • Utility is found in both useful and harmful goods. • Utility is relative – Person, Place, Time • Utility is Psychological, Subjective and Internal • Utility depends on intensity of wants
  2. 2. 2 Concept of Total Utility TU is a function of the quantity of the commodity consumed. MU is the utility of an additional unit
  3. 3. 3 Cardinal Utility Assumptions • Utility is Quantifiable entity. • Utility is both measurable and additive. • Utility is independent (of other commodities) • MU of money remains constant • Introspection- Experience of ‘A’ is supposed to be the same for B,C,D, etc.
  4. 4. 4 • Assumption of Rationally. • Fixed Income and Price. • Stability of tastes (Short Run Theory) • Assumption of divisibility
  5. 5. 5 Law of Diminishing Marginal Utility “ As a consumer increases the consumption of any one commodity, keeping constant of all other commodities, the marginal utility of the variable commodity must eventually decline.” Prof. Boulding
  6. 6. 6 Assumptions of Law • Utility can be measured in cardinal numbers. • All other things remain constant- income etc (Fashion, Tastes, habits etc) • Commodity should not be indivisible
  7. 7. 7 Causes of its operations • Wants are unlimited and can not be satisfied but want for a commodity can be fully satisfied. Does the law of DMU apply to money? Yes and No
  8. 8. 8 Exceptions to the law • Misers, Drunkards, size of initial units, love of power and display, rare and curious things Conclusion: Tendency of law of DMU is so widely prevalent that it would not be wrong to call it a universal law.
  9. 9. 9 Importance of law • Bases of Equi-Marginal utility. • and law of demand. • Helps in price determination. • Basis of socialism/ Progressive Taxation.
  10. 10. 10 Equi-Marginal Principle An input should be so allocated that the value added by the last unit is the same in all cases. A consumer seeking maximum utility from his consumption basket will allocate his consumption budget on goods and services such that MU1 = MU2 = MU3 = MU4 MC1 MC2 MC3 MC4
  11. 11. 11 Similarly, a producer seeking maximum profit would use that technique of production or input-mix which would ensure MRP1 = MRP2 = MRP3 = MRP4 MC1 MC2 MC3 MC4
  12. 12. 12 Law of Equi-Marginal Utility “The household maximizing utility will so allocate its expenditure between commodities in such a way that utility of last penny spent on each is equal.” Lipsey
  13. 13. 13 Importance of law of Equi M utility Consumption- To get maximum satisfaction. Production – Earn maximum profits. Exchange & Price Determination- Exchange is nothing but substitution. Law reduces the scarcity of commodities experiencing rising prices/ shortages by shifting to cheaper substitutes.
  14. 14. 14 Public Finance – Taxes are levied in a manner that the marginal sacrifice of each tax payer is equal. Similarly, the marginal benefit of each type of public expenditure should be equal. International Trade – Countries follows the principle of substitution export a commodity which has lower MU and import a commodity by having higher MU.
  15. 15. 15 Determinants of consumer Equilibrium • Single commodity with single use: Mu=P What happens if Mu>P or Mu<P? When commodity is free P = Mu o = o
  16. 16. 16 Single commodity several uses Mua = Mub = Muc andso on. Several commodities with same price = Mux = Muy = Muz Several commodities with different price = Mu of a = Mu of B = Mu of x P of a P of B Price of x
  17. 17. 17 Law of Diminishing Marginal Rate of Substitution “The MRS of x for y is the amount of y the consumer is just willing to give up to get one more unit of x and maintain the same level of satisfaction. MRSxy – (-) ∆y ∆x MRS is always negative because you can have more by having less of y.
  18. 18. 18 Why MRs Diminishes? The law of DMRS is an extension of law of diminishing marginal utility. Fundamental Assumptions Rational consumer, ordinal utility, DMRS, Two Goods Model.
  19. 19. 19 Substitution Effect Given a constant income of the consumer, a change in the relative price of the two commodities may force a consumer to rearrange his purchases. The consumer will buy more of the commodity which becomes comparatively cheaper. The amount by which the money income of the consumer is changed so that the consumer is neither better off nor worse off than before is called compensating variation in income. Compensating variation in income is a change in the income of the consumer which is just sufficient to compensate the consumer for a change in the price of a good.
  20. 20. 20 Substitutions Effect Substitution effect refers to the change in the consumption or demand for two goods as a result of their relative change in prices, real income remaining constant.
  21. 21. 21 Assumptions of Hicksian Substitution Effect • Money income of the consumer remains the same • The relative prices of two goods change in such a way that one commodity becomes cheaper than the other.
  22. 22. 22 • The Cheapness of one commodity and expensiveness of the other cancel each other by compensating variation technique and therefore consumer is neither better off nor worse off than before. • No Change in consumer’s Tastes and Preferences.
  23. 23. 23 Ordinal Utility Approach Ordinal utility technique is based upon the comparablities of utilities and avoids quantification of utilities. It helps in making a right choice amongst several goods and decide how much of one commodity should be substituted for how much of another, so that the consumer’s level of satisfaction remains the highest.
  24. 24. 24 Ordinal utility asks, “Is ‘A’ preferred to ‘B’. This does not require that we know how much ‘A’ is preferred to B. What is an indifference curve? “A single indifference curve shows the different combinations of x and y that yield equal satisfaction to the consumer.”
  25. 25. 25 Properties of indifference curve • Indifference curve slopes downwards from left to right. • Convex to the origin. • Indifference curve can not intersect/ touch each other. • Higher IC represent higher level of satisfaction. • IC touch neither x axis nor y axis.
  26. 26. 26 Price Line or Budget Line The Budget line or price line shows all the different combinations of two goods that a consumer can purchase given his money income and the price of two commodities. Slope of price line = Px Py • Price line when income of the consumer changes. • Price line when price of x and y changes.
  27. 27. 27 Indifference Map A set of indifference curves is a indifference map. In indifference map all combinations on one indifference curve yield same satisfaction but higher indifference curve represents higher level of satisfaction.
  28. 28. 28 Conditions of Consumer Equilibrium • The Price line should be tangent to IC. • IC should be convex to the point of origin. MRSxy = Px Py
  29. 29. 29 Price Effect as Combination of Income & Substitution Effect • Income Effect: Effect on the purchase of the consumer caused by changes in income, if prices of goods remain constant. • Positive Income Effect: Normal goods. • Negative Income Effect: Inferior goods.
  30. 30. 30 Price Effect The price effect shows how much the satisfaction of the consumer varies due to the change in the consumption of two goods as the price of one changes, the price of the other and money income remains constant. Price effect = Income effect + Substitution effect.
  31. 31. 31 Price effect = Movement from E to E1 Substitution effect = Movement from E to E2 Income Effect = Movement from E2 to E1 PE = SE +IE
  32. 32. 32 Consumer Surplus The difference between what a consumer is willing to pay and what he actually pays is called consumer surplus. Or The gap between total utility of a good and its total market value is called consumer surplus. Because consumers pay the price of last unit for all units consumed, they enjoy a surplus of utility over cost.
  33. 33. Consumer surplus • The money value of consumer surplus • can be measured as the area under the demand curve but above the price line. 33

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