Management and Planning
Management and Planning
Approaches to
consumer
behaviour
Marginal Utility
Marginal Utility of Income Effect and
cannot be
Money does not Substitution Effect
Estimated for all
Remain Constant not Separated
Commodities
Approaches to
Cardinal Utility
• According to this law, as the consumer consumes more and more units of
a commodity, there is a steady decline in the additional utility derived.
Thus, more the consumer consumes, there is an increase in his total utility
but at a diminishing rate. It being very natural that on consuming
additional units of a particular good at a point of time by a consumer, his
intensity of desire diminishes for every additional unit resulting in the
decrease in the utility derived from each additional unit.
• According to Marshall, "The additional benefit which a person derives from
a given increase of a stock of a thing diminishes, other things being equal,
with every increase in the stock of that he already has.”
ASSUMPTIONS OF LAW OF DIMINISHING MARGINAL
UTILITY
• Practically, the consumer spends his income on many available goods and services
but he can only achieve equilibrium of maximum satisfaction or utility if he acts
according to the equi-marginal utility as he is having a fixed income and is facing the
market prices of different goods.
• There should be a correlation between the marginal utilities of different goods and
their prices according to the requirement of the principle of equi-marginal utility.
The basic condition of consumer equilibrium that can be written in terms of
marginal utilities and price of different goods is as follows:
ORDINAL UTILITY
APPROACH
• The number of pairs of two commodities that a consumer keeps in his mind to achieve
equal level of satisfaction is the fundamental idea behind ordinal utility approach. This
infers that the utility can only be ranked in a qualitative manner.
• According to the assumption of cardinal theory, utility is measurable on the contrary;
utility is not measurable according to the ordinal theory. The limitations of the
usefulness of this approach is because, in real life utility is subjective and cannot be
measured.
• The limitations of the cardinal approach that offers valuable awareness to consumer
behaviour motivated economists to develop ordinal utility theory whose approach is
completely different from the states about consumer's behaviour on the assumption
that utility from different units of a good or between different goods can only be rank
able but not measurable. Supposing a consumer gains more utility from good X than
from good Y then he will rank good X above good Y irrespective of the knowledge by
how much X has been given preference.
APPROACHES TO ORDINAL UTILITY
Approaches to
ordinal Utility
Revealed
Indifference
preference
curve
theory
INDIFFERENCE CURVE
Assumption
Non
of
Transitivity satiety
Assumptions
Weak
Consistency
Ordering
Scale of
Preferences
is Transit of
Independent Choice
of Market Diminishing
Prices MRS
INDIFFERENCE CURVE AND INDIFFERENCE SCHEDULE
INDIFFERENCE CURVE AND INDIFFERENCE SCHEDULE
PROPERTIES OF INDIFFERENCE CURVE
The diagram consists of two axes: the horizontal axis represents the quantity of one good, and the vertical
axis represents the quantity of another good. The budget constraint is a straight line that shows all the
combinations of the two goods that can occur with a given income level and the prices of the goods. The
slope of the budget constraint represents the relative prices of the two goods.
The area under the budget constraint represents all the available feasible consumption bundles, given the
income level and prices of the goods. Any point on the budget constraint represents a particular
consumption bundle that exhausts the consumer’s income. The area above the budget constraint
represents unaffordable consumption bundles, given the income level and prices of the goods.
Overall, the revealed preference theory graph provides a visual representation of how consumers choose to
allocate their limited income among different goods based on their preferences and the prices of the goods.
TYPES OF ORDERING : BY HICKS
SIGNIFICANCE OF REVEALED PREFERENCE THEORY
• Behavioristic approach
• More realistic, objective and scientific
• Establishes the law of demand directly
• Requires no restrictive assumptions
• Does not require the assumption of continuity
• Simpler analysis
• Provides a new vista in welfare economics
LIMITATIONS OF REVEALED PREFERENCE THEORY
• Not a general theory of demand
• Bias towards strong ordering
• Over-stresses the consistency condition of rationality
• Imperfect theory
• More an academic exercise
• It has limited scope of applicability