Ordinal Utility Analysis Learning Objective:: Lecture-6

Lecture-6
Ordinal Utility Analysis

Learning Objective:Indifference curve, its properties and Consumer
equilibrium
Indifference curve:
This approach is based on ordinal utility.
The household can choose among combinations without assigning numerical
values to utility. In other words, the term ordinal means, ranked or ordered, first,
second and third are ordinal numbers. Hence this implies that indifference curve
analysis is based on ordinal measurements.
Indifference curve is a curve which shows different combinations of two goods
which yield equal level of satisfaction to the consumer.
It means that different combinations of two goods, yielding same level of
satisfaction to the consumer makes him indifferent about his choice among the
different combinations. In other words, he gives equal importance to all the
combinations on a given indifference curve. Hence an indifference curve
represents a set of possible consumption bundles between which the individual is
indifferent.
Indifference Schedule: An indifference schedule may be defined as the schedule
of various combinations of goods that will yield equal level of satisfaction to a
consumer.
For example
Combination of
( Say ) Apple
and Bananas
A
B
C
D
Apple
Bananas
1
2
3
4
10
7
5
4
The schedule shows that the consumer gets equal satisfaction from all the four
combinations of apple and bananas.
Indifference curve: The diagrammatic presentation of indifference

schedule is indifference curve.
Different points A, B, C and, D on the indifference curve indicate the different

combinations of apple and bananas which yield equal satisfaction to the
consumer. This curve is also known as Iso- Utility curve.
Indifference map: indifference map is the collection of indifference curves possessed

by an individual i.e. a complete description of consumers taste and preferences. For
example IC map is presented in the figure below.
Marginal rate of substitution:

An indifference curve shows that a consumer derives equal level of satisfaction
by consuming the different combination of goods. If a consumer gets one more
unit of good X, he has to give up some units of the other good Y in order to derive
the same level of satisfaction.
In other words, the exchange for the satisfaction obtained from the additional unit
of good X he will have to give up some units of the other good Y whose
satisfaction is equal to the additional unit of good X. Hence
Utility gained of Good X = Utility lost of other good Y

Marginal rate of substitution is the rate at which the consumer can substitute one
good for another good without changing the level of satisfaction. It indicates the
slope of the indifference curve.
Given below is the indifference schedule of a consumer who derives equal level
of satisfaction by consuming the different combinations A, B, C., D and E. When the
consumer moves from combination B to C on his indifference schedule he foregoes 3
units of Y for the additional one unit of X. Hence marginal rate of substitution of X for Y
is 3. and likewise for other combinations.
Indifference Schedule
Combinations of
Good X and Y
A
B
C
D
E
MRSXY
Good X
1
2
3
4
5
Good Y
12
8
5
3
2
1
1
1
1
= Y / X
MRSXY
4
3
2
1
4
3
2
1
Law of Diminishing Marginal Rate of Substitution:

The law of diminishing marginal rate of substitution states that as a consumer
gets more and more units of good X, he will be willing to give up less and less
of good Y to remain at the same level of satisfaction.
For example marginal rate of substitution of good X for Good Y is shown in the table
below.
Combinations
Good X
Good Y
MRSXY
A
1
10
B
2
7
1:3
C
3
5
!:2
D
4
4
1:1
As is evident from this table that consumer will give up 3units of good Y to get
second ,then 2units of good Y to get third unit of good X and so on. This law can
also be illustrated through figure shown below.
10
5
4
IC
Now it comes to ones mind what accounts for the diminishing marginal rate of
substitution. The following three factors are responsible for diminishing marginal rate of
substitution.
The want for a particular good is satiable so that as the consumer has more of a
good the intensity of his want for that good goes on declining.. it is because of
this fall in the intensity of want for good say X, that when its stock increases with
the consumer, he is prepared to forego less and less of good Y for every increment
in X.
The second reason for the decline in marginal rate of substitution
is that the
goods are imperfect substitutes of each other. If two goods are perfect substitutes
of each other then they are to be regarded as one and the same good, and
therefore, increase in the quantity of one and decrease in the quantity of the other
would not make any difference in the marginal significance of the goods.
Thirdly the law of diminishing marginal rate of substitution will hold good only if
the increase in the quantity of one good does not increase the want satisfying
power of the other good.
Assumptions of Indifference curve
Indifference curve analysis is based on the following assumptions
Rational consumer: It is assumed that the consumer I will behave rationally. It
is assumed that consumer has complete information on all matter s relevant to
consumption decisions. He has knowledge of all the goods and services available
in the market, of their prices and his own money income. Given this information
the consumer can determine which combination is preferred or which
combinations yield equal satisfaction.
Ordinal Utility This analysis is based on the assumption of ordinal utility, means
that consumer can rank their preferences for different combinations.
Diminishing Marginal Rate of substitution: It means that as the stock of a
commodity increases with consumer, he substitute it for other commodity at a
diminishing rate.
Non satiety: This means the consumer does not reach the level of satiety. He
always prefers more quantity of a good to less quantity.
Consistency in selection: Means there is consistency in consumers behaviour. If
at any time consumer prefers combination A of goods over combination B, then at
another time he will not prefer B over A.
Transitivity: It means if a consumer prefers A to B and b to C combinations, then
he will definitely prefer A to C combination.
Questions
1.
a)
b)
c)
d)
The diagrammatic presentation of indifference schedule is known as

Demand curve
Supply curve
Indifference curve
Cost curve
2. Indifference curve is a curve which shows different combinations of two goods

which yield _______________ to _the consumer
a) Equal level of satisfaction
b) Different level of satisfaction

c) Both a and b
d) None of the above
3. Indifference curve is also called as
a) Iso-utility curve
b) Demand curve
c) Cost curve
d) All of the above
4. MRSxy and MRSy will be
a) Same
b) Different
c) Both a and b
d) None of the above
5. Indifference curve approach is based on
a) Cardinal utility
b) Ordinal utility
c) Both cardinal as well as ordinal utility
d) All of the above
Answers
1.
2.
3.
4.
5.
c)
a)
a)
b)
b)

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Lecture-6

Ordinal Utility Analysis

Indifference curve: The diagrammatic presentation of indifference

Different points A, B, C and, D on the indifference curve indicate the different

Indifference map: indifference map is the collection of indifference curves possessed

Marginal rate of substitution:

Utility gained of Good X = Utility lost of other good Y

Law of Diminishing Marginal Rate of Substitution:

The diagrammatic presentation of indifference schedule is known as

2. Indifference curve is a curve which shows different combinations of two goods

b) Different level of satisfaction

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