CONSUMER BEHAVIOR

Concept of Cardinal and Ordinal Utility Analysis

Utility is defined as want satisfying power of a commodity. It refers to the satisfaction

obtained from the consumption of a commodity.

Thus, utility denotes satisfaction. More precisely, it refers to how consumers rank
different goods and services.

Utility is a subjective concept. So, it varies with person to person, place to place and
time to time.

Different consumers get different level of satisfaction from the same goods under same
situation.

There are two approaches of utility analysis. They are - cardinal and ordinal
approaches.
 Cardinal Utility Analysis (Marshallian Utility
Analysis)
The concept of cardinal utility was first developed by H.H. Gossen and further
developed by Alfred Marshall. So, it is also called Marshallian Utility Analysis. The
cardinalists defined that utility can be measured in terms of cardinal number. According
to this concept utility (satisfaction) derived from the consumption of a commodity is
measurable and can be express in quantitative terms. Cardinal utility analysis is based
on the following assumptions.
1. Rationality: Cardinal utility analysis assumed that the consumer is rational in the
sense that he/she tries to maximize his/her satisfaction by using goods and services
subject to the budget constraints.
2. Cardinal Measurement: The utility is a cardinal concept. Utility of each
commodity is measurable. It can be measured on the basis of measuring rod of
money.
3. Constant Marginal Utility of Money: According to cardinal utility analysis, the
marginal utility of money remains constant.
4. Diminishing Marginal Utility: The cardinal utility analysis assumed that the
utility obtained from successive units of a commodity consumed decreases as a
consumer consumes more and more units of it.
5. Additive Utility: It is assumed that utility is additive. If there are n commodities in
the bundle consumed by a consumer with quantities x1, x2,…….xn, then total utility
 Types of Utility

Total Utility (TU)

The total utility is the sum total of utilities obtain by the consumer from different units
of a commodity. In other words, the total utility is the aggregate of marginal utilities.
Mathematically, it is expressed as follows:
TU = MU
Or, TU = MU1 + MU2 + … + Mun
Marginal Utility (MU)
The additional unit to total utility that a consumer would derive from one more unit of
consumption of a commodity is defined as marginal utility. In other words, marginal
utility is the ratio of the change in total utility with the change in units of consumption.
Mathematically, it is expressed as follows:
MU =
 Law of Diminishing Marginal Utility
Law of Diminishing Marginal Utility
According to The law of diminishing marginal utility, as a consumer takes more units of
a goods, the extra utility or satisfaction that he derives from an extra unit of the goods
goes on falling. In other words, marginal utility of goods diminishes as an individual
consumer consumes more units of goods.
According to Marshall, “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”.
Assumptions:
This law is based on the following assumptions:
1. The consumer is rational.
2. Utility can be measured in cardinal number.
3. Marginal utility of money remains constant.
4. All the units of consumption are homogeneous.
5. No time gap between consumption.
 Consumer’s Equilibrium under Law of Diminishing
Marginal Utility (Single Commodity Case)
A consumer is said to be in equilibrium position when
he maximizes his level of satisfaction, given his Y
resources. In single commodity case, the consumer
either buy x good or retain his money income. MUX = PX

Marginal Utility/Price
MUX > PX
Under these conditions, the consumer is in equilibrium E
Px
when the marginal utility of x is equal to its market
MUX < PX
price. Thus, MUx = Px

Where, MUx = Marginal Utility of commodity X MUx

Px = Price of commodity X O Qx
X

Units of consumption
 Criticisms of Cardinal Approach
Following are the major criticisms of Marshallian Cardinal Approach:
1. Cardinal measurement of utility is not correct: Marshall assumes that utility is
measurable cardinally, i.e. quantitatively. But it is argued that utility is subjective
term which can neither be measured nor expressed quantitatively. In this regard,
J.R. Hicks and R.G.D. Allen assumed that utility as ordinal. If consumers consume
the goods, the utility derived from these goods can be compared.
2. Constancy of marginal utility of money: Marshall assumes that marginal utility
of money remains constant. But the consumer consumes one commodity and after
another the money will give more marginal utility because of limited amount of
money. Thus, the Marshallian assumption of constancy of marginal utility of money
is not acceptable.
3. Cardinal utility analysis does not split-up price effect in to income effect
and substitution effect: The decrease in price of goods increases the purchasing
power and real income of the consumer. Thus, it is necessary to split up price effect
into income effect and substitution effect. But this point is missed in the cardinal
approach.
4. It is not applied in indivisible goods: Cardinal utility analysis doesn’t explain
anything about the demand for indivisible goods such as TV, computer etc.
 Ordinal Utility Analysis
Utility is only a psychological or subjective factor. So, this can be felt but not measured
in a numerical form
According to P.A. Samuelson and William D. Nordhaus, “In ordinal utility approach
consumers need to determine only their preference ranking of bundles of
commodities.” It is based on the following assumptions.
1. Rationality: The consumer is assumed to be rational, rational in the sense that
he/she tries to maximize the satisfaction from limited resources. It is assumed he
has full knowledge of all relevant information.
2. Ordinal utility: It is assumed that the consumer can rank their preference
according to the satisfaction of each basket.
3. Consistency of choice: It is assumed that the consumer is consistent in his
choice, that is, if in one period he chooses bundle A over B, he will not choose B
over A in another period if both bundles are available to him.
4. Transitivity of choice: It is assumed that consumer’s choices are characterized by
transitivity: if bundle A is preferred to B, and B is preferred to C, then bundle A is
preferred to C. symbolically, if A>B, and B>C, then A>C.
5. Diminishing Marginal rate of substitution: The marginal rate of substitution is
a rate at which a consumer is willing to sutitute one commodity for another.
 Indifference Curve Analysis

The indifference curve analysis measures utility ordinally. It explains consumer’s

behaviour in terms of his preference or making for different combinations of two
goods. Indifference curve is a locus of those combinations of any two goods which
gives the same level of satisfaction to the consumer. This implies that consumer is
indifferent between different combinations or all combinations are equally preferable
to him. The indifference schedule as:
Combination Goods X Goods Y
A 1 12
B 2 8
C 3 5
D 4 3
E 5 2

In the table, the alternative combinations of commodity X and Y yield the same level
of satisfaction to the consumer. Thus, the consumer is indifferent as to whether he
gets the combination A of 1 unit of X and 12 units of Y or combination B with 2 units
of X and 8 units of Y and similarly the combination E with 5 units of X and 2 units of Y.
all these combinations A, B, C, D, and E give the equal satisfaction to the consumer.
 Contd…

It can be presented with the help of following figure:

Y

A
12

10
B
Good Y

6 C

4 D
E
2 IC

X
O
1 2 3 4 5
Good X

In figure, goods X and Y are measured along the X-axis and Y-axis respectively. IC is
the indifference curve derived on the basis of indifference schedule. It states that
when we consume more units of X goods, we must have to reduce the consumption
of Y goods.
 Properties of Indifference Curve
Indifference curves have certain Y
properties reflecting the
assumptions about consumer’s Y1 A
behaviour.
1. Indifference curves slopes Good
downward to the right Y
Y2 B
An indifference curve slopes
downward from lift to right, IC
because when the consumer
wants more units of one X
O X1 X2
goods, he will have to reduce
the units of other goods, if he Good X
wants to remain at the same
In thelevel
figure, both combination A and B yield the same level of satisfaction. When
of satisfaction.
consumer consumes more units of good X, we also have to go on reduce the
consumption of goods Y.
An indifference curve cannot take following shapes
a. Upward sloping curve from left to the right
b. Horizontal straight line parallel to X-axis
 Contd…
Y

2. An indifference curve is convex

A
to the origin 12

An indifference curve is usually 10 –4

B

Good Y
convex to the origin. In other words, 8
indifference curve is relatively –3
6 C
flatter in its right-hand portion and
relatively steeper in its left-hand 4 –2 D
E
portion. Therefore, an indifference 2 –1
IC
curve is convex to the origin.
X
O
1 2 3 4 5
Good X

In figure, consumer gets more and more of good X, he is ready to sacrifice less
and less of good Y. In second combination, MRS is 1X = 4Y, but in the third
combination, MRS is 1X = 3Y. In this way, marginal rate of substitution goes on
diminishing. Since, MRS goes on diminishing an IC cannot be concave to the origin
 Contd…
3. Indifference curves cannot intersect each other
Indifference curves cannot be intersecting each other. In other words, only one
indifference curve will pall through a point in the indifference map. If they intersect,
the consumer’s preferences would not be consistent and transitive.
Y
Good Y

B
In the figure 4.9, A = C since both the points lie
IC2 on the same indifference curve IC1. Similalry A =
C IC1
B since both the points lie on the same
indifference curve IC2. This implies that B = C
O Good X
X but B  C because these two points lie n two
different indifference curves. Hence, indifference
curve cannot intersect with each other.
4. Higher indifference curve represents the higher level satisfaction
The higher indifference curve will represent a higher level of satisfaction than a
lower indifference curve. In other words, the combinations which lie on a higher
indifference curve will be preferred to the combinations which lie on a lower
indifference curve. Y

Good Y
Y2 B
In figure, at combination B on IC2, quantities of
A
both goods X and Y are greater than the Y1
corresponding quantities at point A on IC1. Thus, IC2

utility at point B is higher than the utility at point IC1

A due to more consumption of both goods. IC

O X1 X2
Good X
 Marginal Rate of Substitution (MRS)
The marginal rate of substitution is the rate of exchange between some units of goods
X and Y which are equally preferred. In other words, marginal rate of substitution is the
rate at which one commodity is substituted for another to maintain same level of
satisfaction. The marginal rate of substitution of X for Y (MRS)XY is the amount of Y that
will be give up for obtaining each additional unit of X. Thus,

It can be explained from the following table.

Combination Goods X Goods Y MRS MRSxy = ∆Y/∆X

A 1 12 - -
B 2 8 1X = 4Y -4
C 3 5 1X = 3Y -3
D 4 3 1X = 2Y -2
E 5 2 1X = 1Y -1
 Contd…
In the table, when the consumer moves from the combination A to B in his indifference
schedule 6 unit of Y is sacrificed for the one more unit of X. Hence, the marginal rate of
substitution of X for Y is 4. This behaviour of the consumer is known as the principle of
diminishing marginal rate of substitution.
Y

A
12

10 –4
B

Good Y
8

6 –3 C

4 –2 D
–1 E
2 IC

X
O
1 2 3 4 5
Good X

In the figure 4.11, good-X and good-Y are measured along the X-axis and Y-axis
respectively. In the figure, each time when good-X increases by 1 unit the units of Y
goods that should be given up decreases from 4, 3, 2 to 1 units. As a result, MRS
 Budget Line or Price Line
A budget line shows all those combinations of two goods which the consumer can buy
spending his money income on the two goods at the given price. In other words, the
budget line is the locus of those combinations of two goods that can be purchased with
a given level of income.
The budget line can be explained under following assumptions:
i. Money income of the consumer remains constant.
ii. Price of goods X and Y remains constant
iii. Consumer can spend whole income into two goods.
iv. Budget line can be presented with the help of following equation.
B = PXQX + PYQY
The possible combinations of two goods at given conditions are as follows:
Units of Units of Budget line (Expenditure in
X good Y good Rs.) B = PXQX + PYQY
0 10 10×0 + 5×10 = 50
1 8 10×1 + 5×8 = 50
2 6 10×2 + 5×6 = 50
3 4 10×3 + 5×4 = 50
4 2 10×4 + 5×2 = 50
5 0 10×5 + 5×0 = 50
 Contd…
As shown in the table, if the consumer spends his entire budget on Y good he can
purchase 10 units of good Y (i.e
Similarly, if the consumer spends his entire budget on X good he can purchase 5 units
of good X.
Y
10 A
9
8
Good 7
Y 6 Budget Line
5 B = PX.QY +
4 PY.QY
3
2
1 B
X
O 1 2 3 4 5 6
Good X
In the figure, if a consumer spends all his income in Y good, he can buy OA
amount (10 units) of Y good. Similarly, if a consumer spends all his income in X
good, he can buy OB amount (5 units) of X good. By joining A and B, we derive the
line AB, which is described as the budget line.
 Shift in Budget Line
Y

A1
i. Change in income of consumer
A
The budget line changes its position to the
change in consumer’s income. If the A2

Good Y
consumer’s income increases, price of X
and Y remaining the same, the budget line
shift upward and vice-versa.

X
O B2 B B1
Good X

Let AB be the initial budget line. If the consumer’s income increases while the prices
of both goods X and Y remaining unchanged, the budget line shifts upward from AB
to A1B1. This is because with the increased income the consumer able to purchase
proportionately larger quantity of X and Y.
 Contd…

ii. Change in real income due to change Y Y

in price A
A1

Change in price of goods can change the Good Y Good Y A

real income or purchasing power of the A2
consumer. There is negative relationship
between price and real income. Rise in O X O X
price causes fall in purchasing power B2 B B1 B
Good X Good X
which swing budget line inward and vice- (a) Change in price of X (b) Change in price of Y
versa.

In figure (a), when price of X good falls, the purchasing power of consumer for
X good increases. Hence, budget line swings rightwards from AB to AB 1 along
X- axis. Similarly, when price of X good rises, the purchasing power of
consumer for X good decreases. Hence, budget line swings leftwards from AB
to AB2. In figure (b), when price of Y good falls, the purchasing power of
consumer for Y good increases. Hence, budget line shifts rightwards from AB
to A1B along Y- axis. Similarly, when price of Y good rises, the purchasing
 Consumer’s Equilibrium in Indifference Curve
(Under Ordinal Utility Approach)

As in utility analysis, in indifferent curve it is assumed that the consumer tries to

maximize his satisfaction. In other words, the consumer is assumed to be rational in
the sense that he aims at maximizing his satisfaction from his money income. The
consumer will get maximum satisfaction when the budget line is tangent to the highest
possible indifference curve. It is based on the following assumptions.
i. Consumer must be rational.
ii. Ordinal measurement of utility.
iii. Transitivity in choice.
iv. Diminishing marginal rate of substitution.
v. The goods are homogeneous.
vi. Consumer’s budget is constraint.
Two conditions must be fulfilled for the consumer to be in equilibrium.
 Necessary or first order condition

In order to maximize his satisfaction the consumer will try to reach the highest possible
indifference curve, which he could with a given expenditure of money and given prices
of the two goods. The necessary condition for utility maximization is that the budget
line must be tangent to the indifference curve.
In the figure, AB is a budget line which is tangent to IC2 at point E where consumer
attains maximum satisfaction under the given budget. The IC1 cuts the budget line at
two different points P and Q. But these points give lower satisfaction than point E. IC 3
gives higher satisfaction than IC2 but it cannot be attained under the budget line AB.
Y

A
Good Y

IC3
IC2
Q IC1
O X
B
Good X
 Sufficient or Second Order Condition

The tangency between the budget line and an indifference curve is a necessary
condition but not a sufficient condition for consumer’s equilibrium. The sufficient
condition is that at a point of equilibrium indifference curve must convex to the
origin. The marginal rate of substitution of X for Y must be falling at the point of
equilibrium. Y

A
E
Good Y

R
IC3
IC2
IC1
O X
B
Good X

In figure, there are two tangency points E and R on IC2 and IC1 respectively by the
same budget line. Consumer gets equilibrium at point E because IC 2 is convex to
the origin and tangent with budget line.
 Price Effect

Price effect is the change in consumption of a commodity due to the change in price of
one commodity. The change in price leads to change the consumption of commodity is
called price effect.. In other words, when price change the consumer can buy more or
less units of a commodity. Consumer can purchase less quantity when price is higher
and vice-verse.
Downward sloping price consumption curve (PCC) in case of substitutable
goodsY
In figure, AB is a initial budget line. The
A
consumer is in equilibrium at point P on
IC1. When the price of X goods falls, the
Good Y

price of Y and money income remaining

P Q constant then the real income of the
R
PCC consumer increase because with the
IC1 IC2 IC3 same money income consumer can now
O X purchase more quantity of goods X.
B B1 B2
Good X
 Contd…

Upward sloping price consumption curve (PCC) in case of complementary

goods
Upward sloping price consumption curve for X mean that when the price of good X
falls, the quantity demanded of both goods X and Y rises.
Y

A
Good Y

PCC

R IC3
Q
IC2
P
IC1
O X
B B1 B2
Good X
Contd…
Backward sloping price consumption curve (PCC)
Price consumption curve can also have a backward sloping shape, when price
of X falls, smaller quantity of it is demanded. This is true in case of
exceptional types of goods called Giffen goods.
Y

A PCC
Good Y

R
IC3
Q
IC2
P

IC1
O X
B B1 B2
Good X
Contd…

Horizontal price consumption curve (PCC)

When price of good X falls, its quantity purchases rises proportionately but
quantity purchased of Y good remains the same.
Y
A
Good Y

P Q R
PCC
IC3
IC2
IC1
O X
B B1 B2
Good X
 Income Effect
Y
Income effect shows total effect on demand for
goods due to change in income of the consumer. A2
But price of goods and consumers preferences A1 ICC
remain constant.

Good Y
A R
a. Positive income effects (Normal Goods) Y3
Q
Y2 IC3
P
Where there is an increase in the income, the Y1
IC2
budget line shifts upward. In case of normal IC1
goods, the income effect is positive, in which
O X
the consumer buys more of it when his money X1 X2 X3 B B1 B2
income increases and consumer buy less when Good X
In the
his upper
moneypanel of the
income figure, AB is initial budget
decreases.
Y
line and consumer is in equilibrium at point P on Engel curve

IC1. When, income of the consumer is increased, he Y3

R1

Income
Q1
will be able to purchase larger quantities of both Y2
P1
Y1
the goods.
In the lower panel of figure we can derive income
demand curve (or Engel curve) for normal goods, O
X1 X2 X3
X

(say X good). Demand of X good and income are Good X

 Contd…
b. Negative income effect (Inferior Goods)
Inferior goods are goods that decrease in demand when consumer income rises
and increases in demand when consumer income falls. In other words, inferior
goods are those goods which consumer buys less when income increases and buys
more when income
Y
decreases. So, income
Y
effect is negative on inferior goods.
A2 ICC A
Good Y

Good Y
2
A1 R A
1
A IC3 A
Q
P
Q
P IC2 R
IC1 ICC
IC1 IC2 IC3
O X O X
B B1 B2 B B1 B2
Good X Good X
(a) ICC for X inferior good (b)ICC for Y inferior good

In the figure (a), when income increases budget line shift upwards and consumer is in equilibrium
with higher indifference curve. Here, consumer buys less of X good and more of Y good.
In the figure (b), when income increases budget line shift rightward and consumer is in equilibrium
with higher indifference curve. Here, consumer buys less of Y good and more of X good.
 Substitution Effect
The substitution effect relates to the change in the quantity demand resulting from a change
in the price of goods due to the substitution of relatively cheaper goods for a dearer one,
while keeping the price of other goods and real income of the consumer as constant.
Hicksian approach
Prof. Hicks has explained the substitution effect independent of the income effect through
compensating variation in income. In Hicksian approach substitution effect takes place on
the same indifference curve.
Y
In the figure, point P is the initial equilibrium
A
position of the consumer, where the budget
Good Y

line AB is tangent to IC1. This shows that

E consumer buy OX of X good and OY of Y
P good. When price of X good falls, the budged
Y IC2
Q line shifts upwards from AB to AB1 due to the
Y1 increasing in purchasing power of consumer
IC1
for X good.
O X
X X1 B F B1
Good X
 Decomposition of Price Effect into Income and
Substitution Effect: Fall in Price of Normal Goods
Under Hicksian Approach
Hicks has separated the substitution effect and the income effect from the price effect
through compensating variation in income by changing the relative price of a goods while
keeping the real income of the consumer constant. In this method, increase in real income
has to be decreased in such a way that consumer is neither better off nor worse off or is
Y
in the same IC.
A

Good Y
E
P
Y Q
Y1
R IC2
Y2
IC1

O X
X X2 B X1 F B1
Good X

In fig., the initial budget line is represented by AB and consumer is in equilibrium at point
P purchasing OX units of X good and OY units of Y good. Let, price of X falls and price of Y
good and consumer’ income remain constant as such budget line swings outward to AB 1.
After the fall in price, consumer’s purchasing power increases.
 Superiority of ordinal over cardinal approach

1. Measurement of utility: According to cardinal utility analysis, utility can be

measured quantitatively. But according to ordinal utility, utility is psychological
phenomena. So, utility cannot measure quantitatively.
2. Free from the assumption of constant marginal utility of money:
Cardinal utility analysis assumes constant marginal utility of money. Such an
assumption is not necessary in ordinal utility analysis.
3. Separation of price effect into income effect and substitution effect:
Cardinal utility analysis cannot separate price effect into income effect and
substitution effect. But, it is possible under ordinal utility analysis.
4. Ordinal utility analysis explains the Giffen’s goods: Cardinal utility
analysis does not explain Giffen paradox of effects on consumer’s demand for
inferior goods due to change in income whereas ordinal analysis explains this
phenomenon with the help of negative income effect.
5. Ordinal utility analysis explain with few assumptions: Cardinal analysis
is based on some unrealistic assumption such as cardinal measurement, utility
is independent. Whereas, ordinal analysis is based on some realistic
assumption such as ordinal measurement, diminishing marginal rate of
 Numerical Illustrations
Example –1
From the data given in the following table, derive TU and MU curves, and find
equilibrium quantity at price Rs.10 [10]
Units 1 2 3 4 5 6
Total Utility 20 35 45 50 50 45

From the above table, we can

Solution: derive TU and MU curves as
Units Total Utility (TU) Marginal Utility (MU) follows:
1 20 20 In the diagram, TU represents total
2 35 15 marginal utility curve and MU
3 45 10 represents marginal utility curve.
4 50 5 When TU is increasing, MU is
5 50 0 positive. At point A, TU is the
6 45 -5 maximum and MU is zero. When
TU is decreasing, MU is negative,
According to cardinal utility approach, consumer attains equilibrium when marginal utility is
equal to price. At 3rd unit of the commodity, MU is equal to 10 utils. Therefore, at price Rs.10
equilibrium quantity is 3 units.
 Example –4
Complete the following schedule and answer the given questions.
Combination Commodity 'X' Commodity 'Y' MRS
A 1 15
B 2
C 3
D 4
E 5

From the given table, explain the marginal rate of substitution with the help of diagram.
Solution:
The MRS schedule

Combination Commodity 'X' Commodity 'Y' MRS

A 1 15 -
B 2 10 -5
C 3 6 -4
D 4 3 -3
E 5 1 -2
 Contd…
The above schedule can be explained with the help of following figure.
Y

15 A
Good Y

12
B
9
C
6
D
3
E
IC X
O
1 2 3 4 5
Good X

In the figure X good and Y good are measure along x-axis and y- axis
respectively. Combination A shows 1 unit of X – good and 15 units of Y – good.
Similarly other combination B,C,D, and E shows the combination of (2, 9), (3, 6),
(4, 3) and (5, 1) of X and Y goods respectively. It shows the diminishing marginal
rate of substitution of X for Y good.
Example – 6

Suppose at point P on her IC for goods X and Y, Drishti has 15 units of X and
25 units of Y. when she moves down to point Q on her indifference curve, her
combination of two goods changes to 17 units of X and 24 units of Y. what is
the MRS between points P and Q.
SOLUTION:

Since, MRSXY =
Combinations X goods Y goods
P 15 25
Q 17 24
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