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    4.cardinal Utility Analysis

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    1. Cardinal utility analysis assumes utility is cardinally measurable and consumers seek to maximize satisfaction. The law of diminishing marginal utility and the law of equi-marginal utility determine consumer demand. 2. According to the law of diminishing marginal utility, the marginal utility of a good decreases as its consumption increases. The law of equi-marginal utility states that consumers are in equilibrium when the marginal utility per rupee spent is equal across all goods. 3. When the price of a good decreases, the law of diminishing marginal utility implies consumers will consume more to equalize marginal utility with the new, lower price according to the law of equi-marginal utility, resulting in a downward sloping demand curve.

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    4.cardinal Utility Analysis

    Uploaded by

    Juggy Studio
    180 views26 pages
    1. Cardinal utility analysis assumes utility is cardinally measurable and consumers seek to maximize satisfaction. The law of diminishing marginal utility and the law of equi-marginal utility determine consumer demand. 2. According to the law of diminishing marginal utility, the marginal utility of a good decreases as its consumption increases. The law of equi-marginal utility states that consumers are in equilibrium when the marginal utility per rupee spent is equal across all goods. 3. When the price of a good decreases, the law of diminishing marginal utility implies consumers will consume more to equalize marginal utility with the new, lower price according to the law of equi-marginal utility, resulting in a downward sloping demand curve.

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    Cardinal Utility Analysis

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    4.Cardinal Utility Analysis

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    1. Cardinal utility analysis assumes utility is cardinally measurable and consumers seek to maximize satisfaction. The law of diminishing marginal utility and the law of equi-marginal utility determine consumer demand. 2. According to the law of diminishing marginal utility, the marginal utility of a good decreases as its consumption increases. The law of equi-marginal utility states that consumers are in equilibrium when the marginal utility per rupee spent is equal across all goods. 3. When the price of a good decreases, the law of diminishing marginal utility implies consumers will consume more to equalize marginal utility with the new, lower price according to the law of equi-marginal utility, resulting in a downward sloping demand curve.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
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    180 views26 pages

    4.cardinal Utility Analysis

    Uploaded by

    Juggy Studio
    1. Cardinal utility analysis assumes utility is cardinally measurable and consumers seek to maximize satisfaction. The law of diminishing marginal utility and the law of equi-marginal utility determine consumer demand. 2. According to the law of diminishing marginal utility, the marginal utility of a good decreases as its consumption increases. The law of equi-marginal utility states that consumers are in equilibrium when the marginal utility per rupee spent is equal across all goods. 3. When the price of a good decreases, the law of diminishing marginal utility implies consumers will consume more to equalize marginal utility with the new, lower price according to the law of equi-marginal utility, resulting in a downward sloping demand curve.

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    Download as pptx, pdf, or txt
    of 26

    Demand : Marshallian’s Cardinal

    Utility Analysis.
    • The two approaches of Consumer Demand
    Analysis:
    1. Cardinal Utility/ Neo-Classical Approach
    attributed to Alfred Marshall and his
    followers.
    2. Ordinal Utility/ Indifference Curve Approach
    pioneered by J.R. Hicks, a Nobel laureate and
    R.G.D. Allen.
    Cardinal Utility Analysis.
    • Assumptions:
    1. Rationality.
    2. Utility is cardinally measurable...marginal
    utility is actually measurable in terms of
    money.
    3. Utility is measured in imaginary units called
    ‘utils’.
    4. Constant marginal utility of money.
    5. Independent utilities.
    6. Utility is additive.
    7. Limited money income.
    8. Maximisation of satisfaction.
    9. Introspective method.
    Two important laws.
    • Law of Diminishing Marginal Utility and
    • Law of Equi-Marginal Utility.
    Law of Diminishing Marginal Utility
    • Marshall has stated the law as:
    ‘ The additional benefit which a person derives
    from a given increase of his stock of a thing
    diminishes with every increase in the stock
    that he already has.’
    • It means that as a consumer takes more units
    of a good, the extra/marginal utility that he
    derives from an extra unit of the good goes on
    diminishing.
    • The marginal utility of a good is measurable in
    terms of money that a consumer is willing to
    pay for a unit of the good rather than he
    without it.
    • It is the marginal utility and not total utility of
    a good that declines with the increase in its
    consumption.
    • Marginal utility of money is generally never
    zero or negative.
    • The law of diminishing marginal utility is
    based on 2 important facts:
    1. While the total wants of a man are virtually
    unlimited, each single want is satiable.
    2. Different goods are not perfect substitutes.
    Illustration
    Cups of tea
    consumed
    Total Utility
    (utils)
    Marginal
    Utility (utils)
    • Moving down the table,
    as consumption
    increases, MU
    1 12 12
    diminishes.
    2 22 10
    • TU increases at a
    3 30 8 diminishing rate
    4 36 6 because of declining
    5 40 4 MU.
    6 41 1

    7 39 -2

    8 34 -5
    50 Total Utility Curve
    • Up to the 6th cup of tea, TU 40
    goes on increasing whereas
    30 TU
    after the 6th cup, it declines. T
    •The MU of the additional U 20

    cup up to the 6th cup is 10

    positive whereas beyond the 0


    6th cup, it is negative. 14
    1 2 3 4 5 6 7 8

    •The MU from the additional 12 Marginal Utility


    10 Curve
    cup of tea is diminishing. M 8
    •TU rises up to a point & then U
    6
    declines due to negative MU. 4
    2
    0
    -2 1 2 3 4 5 6 7 8
    -4
    -6 MU
    Principle of Equi-marginal utility/
    Gossen Second Law
    • This law determines consumer’s equilibrium.
    • The law will be governed by 2 important facts:
    1. Marginal utilities of the goods
    2. Prices of the goods
    • The law states that, “the consumer will
    distribute his money income between the
    goods in such a way that the utility derived
    from the last rupee spent on each good is
    equal.”
    • It means that consumer is in equilibrium
    position when marginal utility of money
    expenditure (MUe) on each good is the same.
    • Consider two goods-X & Y-on which the
    consumer has to spend a given income.
    • MUe = MUx/Px
    Where MUx= Marginal utility of good X,
    Px=price of good X.
    • According to the equi-marginal utility
    principle, consumer will be in equilibrium in
    respect of the purchase of goods X & Y, given
    his income, when
    MUx/Px = MUy/Py = MUe
    • If MUx/Px > MUy/Py, consumer will substitute
    good X for good Y thereby MUx will fall till
    MUx/Px = MUy/Py again.
    • How far a consumer will go on purchasing the
    goods depends on the size of his income.
    • Given consumer’s income, he has certain
    marginal utility of money.
    Illustration
    MU of good X and good Y Marginal utility of money expenditure
    Units MUx MUy Units MUx/Px MUy/Py
    1 20 24 1 10 8
    2 18 21 2 9 7
    3 16 18 3 8 6
    4 14 15 4 7 5
    5 12 9 5 6 3
    6 10 3 6 5 1

    •Given Px = Rs. 2, Py = Rs. 3, money income = Rs. 24.


    •The equilibrium position where the consumer maximises his
    utility is 10/2 =15/3 = 5
    •The consumer spends (Rs.2 X 6+Rs.3 X 4)=Rs.24 on goods X & Y.
    GRAPHICAL REPRESENTATION
    • CHECK NOTES
    • Consumer’s equilibrium is where he is buying
    OH of good X & OK of good Y.
    • If he buys 5 units (OA) of good X & 5 units (OL)
    of good Y, Total utility will decrease.
    • Loss in utility ABCH exceeds gain in utility
    KEFL.
    • The principle of equi-marginal utility will hold
    even when a consumer spends his money
    income on several goods. Thus,
    MUx/Px = MUy/Py =................=MUn/Pn = MUe
    • Limitations
    1. Difficulty in weighing marginal utilities of
    different commodities.
    2. Cardinal measurement of utility.
    3. Indivisibility of certain goods.
    Derivation of the demand curve and
    the law of demand.
    Single commodity case • The law of diminishing
    Fig.3 marginal utility states that
    as the quantity of a good
    M with a consumer increases,
    U MU of the good to him
    &P E
    expressed in terms of
    p
    r E’ money falls.
    P’
    i • Consumer will go on
    c
    e purchasing a good till MU of
    MU
    the good equals the market
    price.
    0 Q1 Q2

    Quantity
    • Therefore the consumer will be in equilibrium
    in respect of the quantity of a good purchased
    where MU of the good equals its price.
    • If price falls, downward sloping MU curve
    implies a consumer buy more of the good till
    MU of the good equals its price.
    • Therefore, diminishing marginal utility curve
    implies downward sloping demand curve, i.e.,
    as the price of the good falls, more of it will be
    bought.
    2. Multi-commodity case (NO NEED).
    • According to the law of equi-marginal utility,
    given two goods, X & Y and money income, a
    consumer will be in equilibrium when
    MUx/Px = MUy/Py = MUe
    Where MUx= Marginal utility of good X,
    Px=price of good X, MUy= Marginal utility of
    good Y, Py=price of good Y, MUe =marginal
    utility of money expenditure.
    • If, ceteris paribus, Px falls, consumer’s
    equilibrium will be disturbed.
    • MUx/Px > MUy/Py or Mue
    • MUx must be reduced to attain equilibrium.
    • This can be done by increasing consumption
    of good X.
    • Thus, as price of good X falls, quantity
    demanded of it will rise which will make
    demand curve downward sloping.
    Graphical explanation
    Fig.4 •Given a certain income, the consumer
    is in equilibrium buying Oq1 of good x
    when price is Px1 & where marginal
    utility of money OH is equal to
    Mux
    /Px MUx
    MUx MUx/Px1.
    /Px3
    MUx
    /Px 1
    /P x2
    MUe •When price falls to OPx2, the curve
    H
    will shift to MUx/Px2...equilibrium is
    disturbed
    •To attain equilibrium, MUx must fall
    0 Quantity q1 which can be done by increasing the
    q2 q3
    consumption of x to q2.
    D
    •Thus, with the fall in the price of x,
    A
    P Px1 the consumer buys more of it.
    r
    I B •The lower portion of the figure shows
    P x2
    c the relationship between price and
    e
    Px3 C quantity demanded of x-the demand
    D’ curve DD’.
    0
    q1 q2 q3
    Quantity
    Critical evaluation.
    • Cardinal measurability of utility is unrealistic.
    • Hypothesis of independent utilities is wrong.
    • Assumption of constant marginal utility of
    money is not valid.
    • Marshallian demand function cannot
    genuinely be derived except in a one
    commodity case.
    • Cardinal utility analysis does not split up the
    price effect into substitution and income
    effects.
    • Marshall could not explain Giffen paradox.
    • Cardinal utility analysis assumes too much &
    explains too little.
    Thank you.

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