Presentation

Ordinal Utility analysis or Indifference Curve Approach

I. Introduction to Utility analysis
Utility
Utility is the satisfaction gained by consumers
from consumption of goods and services, or it
can also be defined as the ability of a good to
provide satisfaction to its consumer.
Utility analysis
Concept of utility analysis
Assumption of utility analysis
Law of utility analysis

Concept of Utility analysis and
relationship
Three concept:
Initial utility
Marginal utility
Total utility

Initial utility
The utility derived from the first unit of a
commodity is called initial utility. It is always
positive.



Marginal utility:
MU is the addition made to total utility by
consuming one more unit of the commodity.
MU= TUn Tun-1
MU = Change in TU
Change in Q
MU can be (i) positive, (ii) Zero, (iii) Negative.

Marginal Utility
Positive MU: consuming additional units of a
commodity, TU goes on increasing then the
MU will be +.
Zero MU: if the consumption of an additional
unit of a commodity causes no changes in TU
then the MU will be zero.
Negative MU: if the consumption of an
additional unit of a commodity causes fall in
TU then the MU will be negative.
CARDINAL UTILITY THEORY


Cardinal utility theory is a method which
assumes that satisfaction can be
measured using the unit of util.

Cardinal utility theory was introduced by Alfred
Marshall.
Total Utility and Marginal Utility
Total Utility (TU) is the total satisfaction gained
from a given level of consumption of a good.
Marginal utility (MU) is the increase in total
utility when consumption increases by 1 unit.

MU = Change in TU
Change in Q
Total Utility and Marginal Utility
Quantity Total Utility Marginal Utility
(Q) (TU) (MU)
1 10 10
2 22 12
3 30 8
4 36 6
5 38 2
6 38 0
Relationship between TU an MU
When MU is +ve then TU increase
When MU is zero then TU is maximum
When MU ve then TU decrease
The Law of Diminishing Marginal
Utility
Law of diminishing marginal utility means that
the marginal utility obtained from the
consumption of additional unit will start to
decrease after a certain level of consumption
when the amount consumed increases.
Law of Diminishing Marginal Utility
Gossen first law
According to Alfred Marshall the additional utility which a person derive
from the consumption a commodity diminishes, that is Total Utility increase
at an diminishing rate

Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10
2 20
3 29
4 37
5 43
6 48
7 51
8 52
9 52
10 50
MUn = TUn TUn-1
MU =TU/Q
Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
Law of Diminishing Marginal Utility
the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
TU
MU
No of mango
No of mango
TU
MU
Law of Diminishing Marginal Utility
TU
MU
Saturation Point MU =0 or TU is maximum
TU
MU
No of mango
No of mango
1. Consumer is rational or Rationality :
Consumers Objective is maximization of utility, subject to Price and consumption
expenditure
2. Utility is ordinal:
Utility cannot be measured cardinally. It can be expressed ordinally can rank
according to the satisfaction or utility of each basket.
3. Consistence in choice :
if the consumer prefers combinations of A of good to the combinations B of goods,
he then remains consistent in his choice.
If A > B, then never become B > A

Assumption of Cardinal Utility Analysis or Indifference Curve approach
4. Consumers Preference is Transitive:
A is preferred over combination B is preferred over C, then combination A is
preferred over combination A is preferred over C.
If A > B and B > C, then A > C
5. Diminishing Marginal Substitution of goods:
In the Indifference Curve analysis, the principle of Diminishing Marginal Rate of
Substitution is assumed. That is Convexity of Indifference curve or Negative slop
of indifference
6. Dependent Utility:
TU = f( q1 + q2 + q3 + . . . . . .+ qn)
7. A Large bundle of goods preferred to small bundle
III. Assumption of Cardinal Utility Analysis or Indifference Curve approach
Consumers Equilibrium
CE refers to a situation wherein a consumer
gets maximum satisfaction out of his limited
income he has no tendency to make any
change in his existing pattern.
Consumers Equilibrium:
Assumption
Consumer is rational
MU of money is constant
Fixed income and price
Taste are constant
Perfect knowledge
Determination of Consumers
Equilibrium
A single commodity with single use
A single commodity with several use
Several commodities


Criticism of Consumers
equilibrium
Consumer is not rational
MU of money does not remain constant
Money is not satisfactory measure of utility


The Indifference curve was invented by F Y Edgeworth

An Indifference curve is the locus point of all those combination
of two commodity that yield same level of satisfaction or
utility to the consumer.
Meaning of Indifference Curve
An Indifference curve is the locus point of all those combination of two
commodity that yield same level of satisfaction or utility to the
consumer
Various Combinations:
Utility
Combination Unit of Rice Unit of Wheat
a) 16 kg of Rice 2 kg of Wheat 100u
b) 12 kg of Rice 5 kg of Wheat 100u
c) 11 kg of Rice 7 kg of Wheat 100u
d) 10 kg of Rice 10 kg of Wheat 100u
e) 9 kg of Rice 15 kg of Wheat 100u
Meaning of Indifference Curve
An Indifference curve is the locus point of all those combination of two commodity that yield same level of
satisfaction or utility to the consumer
Various Combinations:
Utility
Unit of Rice
Unit of
Wheat
a 16 2 100u
b 12 5 100u
c 11 7 100u
d 10 10 100u
e 9 15 100u
Meaning of Indifference Curve
An Indifference Map
A graph showing a whole set of indifference curves is called an indifference map. An
indifference map, in other words, is comprised of a set of indifference curves. Each
successive curve further from the original curve indicates a higher level of total
satisfaction.
VI. Marginal Rate of Substitution of goods MRS xy
The concept of Marginal Rate Substitution (MRS) was introduced by Dr. J.R. Hicks and
Prof. R.G.D. Allen to take the place of the concept of diminishing marginal utility.
The slop of indifference curve is known as Marginal Rate of Substitution MRS
The rate or ratio at which goods X and Y are to be exchanged is known as the
marginal rate of substitution (MRS).
The marginal rate of substitution of X for Y measures the number of units of Y that
must be scarified for one unit of X gained so as to maintain a constant level of
satisfaction.
MRS xy = Change in good X / Changes in good Y - MRS xy =
VI. Marginal Rate of Substitution of goods MRS xy
MRS : The marginal rate of substitution of X for Y measures the number of units of Y
that must be scarified for unit of X gained so as to maintain a constant level of
satisfaction.
Combination Apple X Mango Y Utility Ratio MRS
A 1 15 100 - -
B 2 10 100 5:1 5
C 3 6 100 4:1 4
D 4 3 100 3:1 3
E 5 1 100 2:1 2
MRS xy = Change in good X / Changes in good Y - MRS xy =
VI. Marginal Rate of Substitution of goods MRS xy
MRS : The marginal rate of substitution of X for Y measures the number of units of Y
that must be scarified for one unit of X gained so as to maintain a constant level of
satisfaction.
MRS xy = Change in good Y / Changes in good X - MRS xy =
VI. Marginal Rate of Substitution of goods MRS xy
MRS : The marginal rate of substitution of X for Y measures the number of units of Y
that must be scarified for unit of X gained so as to maintain a constant level of
satisfaction.
Combination Apple X Mango Y Ratio MRS
A 2 30
B 4 20
C 6 12
D 8 6
E 10 2
MRS xy = Change in good X / Changes in good Y - MRS xy =
VI. Marginal Rate of Substitution of goods MRS xy
MRS : The marginal rate of substitution of X for Y measures the number of units of Y
that must be scarified for unit of X gained so as to maintain a constant level of
satisfaction.
Combination Apple X Mango Y Ratio MRS
A 2 30 - -
B 4 20 10:2 5
C 6 12 8:2 4
D 8 6 6:2 3
E 10 2 4:2 2
MRS xy = Change in good X / Changes in good Y - MRS xy =
VI. Marginal Rate of Substitution of goods MRS xy
VII. Principles of Diminishing Marginal Rate of Substitution of goods MRS xy
This behaviour showing falling MRS of good X for good Y and yet to remain at the same
level of satisfaction is known as Diminishing Marginal Rate of Substitution.
Combination Apple X Mango Y MRS
A 1 15 -
B 2 10 5
C 3 6 4
D 4 3 3
E 5 1 2
VII. Principles of Diminishing Marginal Rate of Substitution of goods MRS xy
(1) Indifference Curves are Negatively Sloped:
It slopes downward because as the consumer increases the consumption of X commodity, he
has to give up certain units of Y commodity in order to maintain the same level of
satisfaction.
V. Properties/Characteristics of Indifference Curve
(2) Indifference Curve are Convex to the Origin:
the consumer substitutes commodity X for
commodity Y, the marginal rate of substitution
diminishes of X for Y along an indifference
curve.
Principle of Diminishing Marginal Rate of
Substitution
V. Properties/Characteristics of Indifference Curve
V. Properties/Characteristics of Indifference Curve
(3) Higher Indifference Curve Represents Higher Level
A higher indifference curve that lies above and to the right of another indifference
curve represents a higher level of satisfaction and combination on a lower
indifference curve yields a lower satisfaction.
V. Properties/Characteristics of Indifference Curve
(4) Indifference Curve Cannot Intersect Each Other:
Given the definition of indifference curve and the assumptions behind it, the
indifference curves cannot intersect each other. It is because at the point of tangency,
the higher curve will give as much as of the two commodities as is given by the lower
indifference curve.
V. Properties/Characteristics of Indifference Curve
(5) Indifference Curves do not Touch the Horizontal or Vertical Axis:

One of the basic assumptions of indifference curves is that the consumer purchases
combinations of different commodities. He is not supposed to purchase only one
commodity.
V. Properties/Characteristics of Indifference Curve
VIII. Price Line or Budget Line
A budget line or price line represents the various combinations of two goods which can
be purchased with a given money income and assumed prices of goods".
Market
Basket
Biscuit
Qx
Coffee
Qy
A 10 0
B 8
C 6
D 4
E 2
F 0 5
Income (Y)= 60 , Price of Biscuit (Px) = 6, Price of Coffee(Py) = 12
Price Line or Budget Line
VIII. Price Line or Budget Line
Combination Biscuit Coffee
A 10 0
B 8 1
C 6 2
D 4 3
E 2 4
F 0 5
A budget line or price line represents the various combinations of two goods which can
be purchased with a given money income and assumed prices of goods".
Income (Y)= 60 , Price of Biscuit (Px) = 6, Price of Coffee(Py) = 12
VIII. Price Line or Budget Line
IX. Slop of Price Line or Budget Line
IX. Slop of Price Line or Budget Line
The slope of the budget line indicates how many packets of biscuits a purchaser
must give up to buy one more packet of coffee. For example, the slope at point B on
the budget line is Y / X
X. Changes or Shift in Price Line or Budget Line
The price line is determined by the income of the consumer and the prices of goods in
the market. If there is a change in the income of the consumer or in the prices of goods,
the price line shifts in response to a exchange in these two factors.
(i) Income changes: When there is change in the income of the consumer, the prices of
goods remaining the same, the price line shifts from the original position. It shifts
upward or to the right hand side in a parallel position with the rise in income.
(ii) Price changes. If there is a change in the price of one good, the income of the consumer
and price of other good is held constant. When there is a fall in the price of one good say
commodity A, the consumer purchases more of that good than before. A price change
causes the budget line to rotate
X. Changes or Shift in Price Line or Budget Line
(i) Income changes: When there is change in the income of the consumer, the prices of
goods remaining the same, the price line shifts from the original position. It shifts
upward or to the right hand side in a parallel position with the rise in income.
Rise in income.
A fall in Income?????
X. Changes or Shift in Price Line or Budget Line
(ii) Price changes. If there is a change in the price of one good, the income of the
consumer and price of other good is held constant. When there is a fall in the price of one
good say commodity A, the consumer purchases more of that good than before. A price
change causes the budget line to rotate
What will happen to Price Line
Price of commodity B fall?
Price of Commodity B Rice ?
Price of commodity A rice ?
X. Changes or Shift in Price Line or Budget Line