Ordinal Approach (Indifference Curve Analysis)

One of the major criticisms of cardinalist approach is that utility can be measured.
According to the Ordinalist the consumer isn’t capable of assigning quantitative
units of utility to commodity but he /she is only able to rank commodities in the
order of preference.
This means that given a choice between A and B, the consumer is only able to rank
them so that either A is preferred or B is preferred to A or the consumer is in
different between A and B. A is preferred to B and B is preferred to A.

Assumptions
1) Consumer is rational: The consumer aims is to maximize utility subjected
to the given level of income.
2) Utility is ordinal: Meaning that utility isn’t measureable but the consumer
is able to rank commodities in on order of preference.
3) Completeness: Assumes that a consumer is capable of making a choice.
That is given a choice between A and B the consumer must make one of the
following decisions either he prefers A to B, or prefers B to A or he is
indifferent between A and B.
4) Consistency: If the consumer is choosing between A and B and he prefers
A to B then the consumer must not prefer B to A at any other time as long
as both A and B are available.
5) Transitivity: means that if he prefers A to B and B to C then A must be
preferred to C. (APC)

The consumer level of preference is represented by an indifferent curve. An

indifference curve is a locus or a curve that joins together different combination of
goods that yield the same level of utility to a consumer .e.g. suppose the consumer
consumes two goods X and Y and that utility is obtained by;

U = x + y.
If U =12 it’s possible to obtain different combinations of X and Y that satisfy the
utility equation.

X Y
0 12
2 10
4 8
6 6
12 0

The schedule above shows the different combination of goods X and Y that the
consumer would be indifferent to. The indifference schedule produces an
indifferent curve as shown:

Properties of Indifference Curves

1) They are everywhere dense. On the quadrant every point is a combination

of goods and every combination must lie on the Indifference Curve.
2) Indifference Curve should not intersect this is because one combination
cannot yield more than one level of utility to the consumer.
3) Higher indifference curves yield higher levels of utility - that is the higher
the Indifference Curve the higher is the level of utility it represents.

Good X
 Good Y

The Indifference Curve slopes downward from the left to the right. This means that
if the consumer wishes to consume more units of one of the goods and maintain
the utility level some units of the other goods must be sacrificed. That is there
must be substitution.

The Indifference Curve must be convex to the original. This implies that as the
consumer give up more and more units of one good, successfully larger unit of the
other good must be obtained to compensate the consumer for the loss of the utility
level.

Slope of Indifference Curve

It is referred to as a Marginal Rate of Substitution (MRS). It’s the ratio which two
goods can be substituted without changing the level of utility. It measures the
number of units of one good that must be given up in order consume one extra
unit of the other goods, utility remaining constant.
Consider an indifference Slope:

Good X Good Y
1 12
2 6
3 4
4 3
6 2
12 1

MRS = ∆y = 4-6 = -2 = -2
∆x 3- 2 1

From, a utility function point of view the slope of an IC is the negative ratio of the
Mux of the two goods.

MUx
MRS xy =
MUy

Consumer Budget Constant

The consumer’s objective to maximize utility is subject to the constraints of his

income. Considering two goods X and Y let Px and Py represent the units price of
Good X and Y respectively and let M represent the consumer level of income. The
consumer budget assuming only two goods X and Y will be stated as:

Px + Py ≤ M
Assuming no other goods than x and y:

Px + Py = M

Let Px = Ksh 20 and Py be Ksh 10 and income M =100

The consumer’s budget constraint is given by:

20X +10Y =100

It’s possible to identify different combination of X and Y that meets the budget
constraint:

Budget Schedule

X Y
0 10
1 8
2 6
3 4
4 2
5 0

Slope of the budget line

Consider the budget constraint:
Px X +PyY = M
Py Y =M - PxX
Y = M – PxX
Py Py
The slope of a budget line is a relative price or a ratio of prices. It measures the
amount of one good that must be given up in order to use an extra unit of the other
good income remaining constant.

The above example depicts the slope of the budget line.

20x +10y =100
10y =100 -20x
Y =10 -2x
∆y = -2
∆x
Using the above budget schedule it produces a budget line.
Good Y

B
A

Good X 5 10

Combination (A) is achievable and affordable because the some of the consumer’s
income will remain unspent.
Suppose the price of good X falls by 50%, the new budget line will be:
10x +10y =100
X =0 Y =10
Y =0 X =10
Suppose Px Increase by 50% then:

30X +10Y =100

X =0 Y = 10
Y =0 X = 3.3
A change in the price of commodity pivots the budget line along the bundle of the
goods whose price is changing. Specially a fall in price pivots the budget line
outwards while an increase in price pivots the budget line inwards.
From the above example, suppose the income increase by50%, holding the price
constant:
20x +10y = 150
X =0 y =15
X =7.5 y =0
GOOD Y
15

10

Increase in Income

Falling Income

5
GOOD X
Changing the consumer income results in a shift of the budget line. Specifically an
increase in income shifts the budget line to the right while a fall in income shifts
the budget line to the left.

Consumer Equilibrium
Consumer Indifference Curves are drawn on the same graph with the budget, the
following will be the configurations:

Good Y

YE e

Budget Line

XE
Good X
The tangency of indifference curve and budget line is referred to as the consumer
equilibrium price. It is the tangency that depicts a point of contact between the
consumer budget line and the highest possible IC. The combination of goods that
maximizes utility subject to the budget constraints. At the point e, the slope of the
budget line is equal to that of the IC that is:
MUx Px
=
MUy Py

(Equilibrium condition for utility maximization)

 a. The condition is used to be the first and necessary for utility maximization.
Here it is not sufficient.
b. The second and the sufficient condition for utility maximization is that the
IC must be convex to the origin.
Income Consumption /Offer Curve
Consider the consumer equilibrium point:

Good Y

Good X
A change in income results to a shift in the budget line either to the right or left.
An increase in income shifts the budget line to the right. Along every new budget,
as income changes, there is a point of tangency with the respective indifference
curves. Such points of tangency are all consumer equilibrium points as shown in
the diagram:
Good Y

Good X
A curve which joins together all the different consumer equilibrium points as
income change is referred as an income offer curve /consumption curve.

Price Offers /Consumption Curve

A change in price pivots the budget line along the axis of the good whose price is
changing.
Along every new budget line as the price changes, there a point of tangency with
the respective indifference curve. A curve which joins together the different
consumer equilibrium points as the pace changes is a price offer
curved /consumption curve.

Good Y

Good X
SUMMARY

 Demand is the quantity that buyers wish to buy at each price. Other things equal, the
lower the price, the higher the quantity demanded. Demand curves slope down.

 Supply is the quantity of a good seller’s wish to sell at each price. Other things equal,
the higher the price, the higher the quantity. Supply curves slope upwards.

 Elasticity of the demand and supply showing the degree of responsiveness of demand
and supply due to changes in the factors of production.

 The market clears, or is in equilibrium, when the price equates the quantity supplied
and the quantity demanded. At prices below the equilibrium price there is excess
demand (shortage), and at prices above the equilibrium price there is excess supply
(surplus), which itself tends to reduce the price.

 In the consumer theory, there are two main consumption analyses. That is the Ordinal
and cardinal approaches. The Cardinal approach assumes consumers can quantify
their satisfaction while the ordinal approach assumes that the consumers can only
rank their preferences
REVIEW QUESTIONS
i. What happens to the demand curve for toasters if the price of bread rises? Show
in a supply-demand diagram how the equilibrium price and quantity of toasters
change.
ii. How is the demand curve for pagers affected by the invention of the mobile
phones if people prefer this new way of communicating? What happens to the
equilibrium quantity and price of pagers?
iii. You are a Tea farmer. Give three examples of a change that would reduce your
supply of tea. Did you use a fall in the price of tea as one of your examples? Is it
valid example?
iv. What happens to a consumer’s equilibrium in the ordinal approach if the income
increases?