1. 1
Cardinal Utility Approach
What is utility?
• A want satisfying capacity of a commodity
or service.
• Utility is found in both useful and harmful
goods.
• Utility is relative – Person, Place, Time
• Utility is Psychological, Subjective and
Internal
• Utility depends on intensity of wants

2. 2
Concept of Total
Utility
TU is a function of the
quantity of the commodity
consumed.
MU is the utility of an
additional unit

3. 3
Cardinal Utility Assumptions
• Utility is Quantifiable entity.
• Utility is both measurable and
additive.
• Utility is independent (of other
commodities)
• MU of money remains constant
• Introspection- Experience of ‘A’ is
supposed to be the same for B,C,D,
etc.

4. 4
• Assumption of Rationally.
• Fixed Income and Price.
• Stability of tastes (Short
Run Theory)
• Assumption of divisibility

5. 5
Law of Diminishing Marginal
Utility
“ As a consumer increases the
consumption of any one
commodity, keeping constant of
all other commodities, the
marginal utility of the variable
commodity must eventually
decline.”
Prof. Boulding

6. 6
Assumptions of Law
• Utility can be measured in
cardinal numbers.
• All other things remain constant-
income etc (Fashion, Tastes,
habits etc)
• Commodity should not be
indivisible

7. 7
Causes of its operations
• Wants are unlimited and can not
be satisfied but want for a
commodity can be fully satisfied.
Does the law of DMU apply to
money?
Yes and No

8. 8
Exceptions to the law
• Misers, Drunkards, size of initial
units, love of power and display,
rare and curious things
Conclusion: Tendency of law of
DMU is so widely prevalent that it
would not be wrong to call it a
universal law.

9. 9
Importance of law
• Bases of Equi-Marginal
utility.
• and law of demand.
• Helps in price determination.
• Basis of socialism/
Progressive Taxation.

10. 10
Equi-Marginal Principle
An input should be so allocated
that the value added by the last
unit is the same in all cases. A
consumer seeking maximum utility
from his consumption basket will
allocate his consumption budget
on goods and services such that
MU1 = MU2 = MU3 = MU4
MC1 MC2 MC3 MC4

11. 11
Similarly, a producer
seeking maximum profit
would use that technique of
production or input-mix
which would ensure
MRP1 = MRP2 = MRP3 = MRP4
MC1 MC2 MC3 MC4

12. 12
Law of Equi-Marginal
Utility
“The household maximizing
utility will so allocate its
expenditure between
commodities in such a way
that utility of last penny
spent on each is equal.”
Lipsey

13. 13
Importance of law of Equi
M utility
Consumption- To get maximum
satisfaction.
Production – Earn maximum profits.
Exchange & Price Determination-
Exchange is nothing but
substitution. Law reduces the
scarcity of commodities
experiencing rising prices/ shortages
by shifting to cheaper substitutes.

14. 14
Public Finance – Taxes are levied
in a manner that the marginal
sacrifice of each tax payer is equal.
Similarly, the marginal benefit of
each type of public expenditure
should be equal.
International Trade – Countries
follows the principle of
substitution export a commodity
which has lower MU and import a
commodity by having higher MU.

15. 15
Determinants of consumer
Equilibrium
• Single commodity with single use:
Mu=P
What happens if Mu>P or Mu<P?
When commodity is free
P = Mu
o = o

16. 16
Single commodity
several uses
Mua = Mub = Muc andso on.
Several commodities with same
price = Mux = Muy = Muz
Several commodities with different
price =
Mu of a = Mu of B = Mu of x
P of a P of B Price of x

17. 17
Law of Diminishing Marginal
Rate of Substitution
“The MRS of x for y is the amount
of y the consumer is just willing to
give up to get one more unit of x
and maintain the same level of
satisfaction.
MRSxy – (-) ∆y
∆x
MRS is always negative because
you can have more by having less
of y.

18. 18
Why MRs Diminishes?
The law of DMRS is an extension of
law of diminishing marginal utility.
Fundamental Assumptions
Rational consumer, ordinal utility,
DMRS, Two Goods Model.

19. 19
Substitution Effect
Given a constant income of the consumer, a
change in the relative price of the two
commodities may force a consumer to
rearrange his purchases. The consumer will
buy more of the commodity which becomes
comparatively cheaper. The amount by which
the money income of the consumer is
changed so that the consumer is neither
better off nor worse off than before is called
compensating variation in income.
Compensating variation in income is a
change in the income of the consumer which
is just sufficient to compensate the
consumer for a change in the price of a good.

20. 20
Substitutions Effect
Substitution effect refers to
the change in the
consumption or demand for
two goods as a result of
their relative change in
prices, real income
remaining constant.

21. 21
Assumptions of Hicksian
Substitution Effect
• Money income of the
consumer remains the same
• The relative prices of two
goods change in such a way
that one commodity
becomes cheaper than the
other.

22. 22
• The Cheapness of one
commodity and expensiveness
of the other cancel each other
by compensating variation
technique and therefore
consumer is neither better off
nor worse off than before.
• No Change in consumer’s
Tastes and Preferences.

23. 23
Ordinal Utility Approach
Ordinal utility technique is based
upon the comparablities of utilities
and avoids quantification of utilities.
It helps in making a right choice
amongst several goods and decide
how much of one commodity should
be substituted for how much of
another, so that the consumer’s
level of satisfaction remains the
highest.

24. 24
Ordinal utility asks, “Is ‘A’
preferred to ‘B’. This does not
require that we know how much ‘A’
is preferred to B.
What is an indifference curve?
“A single indifference curve shows
the different combinations of x and
y that yield equal satisfaction to
the consumer.”

25. 25
Properties of indifference
curve
• Indifference curve slopes
downwards from left to right.
• Convex to the origin.
• Indifference curve can not
intersect/ touch each other.
• Higher IC represent higher level of
satisfaction.
• IC touch neither x axis nor y axis.

26. 26
Price Line or Budget Line
The Budget line or price line shows all
the different combinations of two
goods that a consumer can purchase
given his money income and the price
of two commodities.
Slope of price line = Px
Py
• Price line when income of the
consumer changes.
• Price line when price of x and y
changes.

27. 27
Indifference Map
A set of indifference curves is a
indifference map. In
indifference map all
combinations on one
indifference curve yield same
satisfaction but higher
indifference curve represents
higher level of satisfaction.

28. 28
Conditions of Consumer
Equilibrium
• The Price line should be
tangent to IC.
• IC should be convex to the
point of origin.
MRSxy = Px
Py

29. 29
Price Effect as Combination of
Income & Substitution Effect
• Income Effect: Effect on the
purchase of the consumer caused
by changes in income, if prices of
goods remain constant.
• Positive Income Effect: Normal
goods.
• Negative Income Effect: Inferior
goods.

30. 30
Price Effect
The price effect shows how much
the satisfaction of the consumer
varies due to the change in the
consumption of two goods as the
price of one changes, the price of
the other and money income
remains constant.
Price effect = Income effect +
Substitution effect.

31. 31
Price effect = Movement
from E to E1
Substitution effect =
Movement from E to E2
Income Effect = Movement
from E2 to E1
PE = SE +IE

32. 32
Consumer Surplus
The difference between what a
consumer is willing to pay and
what he actually pays is called
consumer surplus. Or The gap
between total utility of a good and
its total market value is called
consumer surplus.
Because consumers pay the price
of last unit for all units consumed,
they enjoy a surplus of utility over
cost.

33. Consumer surplus
• The money value of consumer surplus
• can be measured as the area under the
demand curve but above the price line.
33