THE CARDINAL UTILITY THEORY *.Introduction *.Assumptions *.Equilibrium of the Consumer *.Derivation of the demand curve *.Limitations Introduction *.Demand refers to a desire for a good backed by ability and willingness to pay. It refers to the quantity demanded for goods and services at different prices in given period. *.In other words, it is the quantity of a commodity that a person is willing to buy at a given price in a specified period of time *.Demand is a multivariate relationship. It is determined by many factors simultaneously: its own price, consumers income, price of other commodities, tastes, income distribution, total population , consumers wealth, credit availability, Govt. policy, past levels of demand & fast levels of income, advertisement, etc. *.The traditional theory of demand has concentrated on four of the above determinants (price, income, price of other goods and taste Approaches to behavior of consumer *.A) The Cardinalist approach ; B) Ordinalist approach *.A). The cardinalist school postulated that utility can be measured. Some economists suggested that utility can be measured in monetary units by the amount of money the consumer is willing to sacrifice for another unit of commodity *.Others suggested the measurement of utility in subjective units called utils by Walras *.B).The ordinalist school postulated that utility is not measurable; it is on ordinal magnitudes. The consumer need not know utility of various commodities in specific units to make his choice. *.It is sufficient for him if he is able to rank the various baskets of goods according to the satisfaction that each bundle gives him. Assumptions 1.Rationality:The consumer is assumed to be rational. 2.Cardinal utility:The utility of each commodity is measurable in terms of money. The utility is measured by the monetary units that the consumer is prepared to pay for another unit of the commodity. 3.Constant marginal utility of money: If the marginal utility of money changes as income increases or decreases, the measuring rod for utility becomes like an elastic ruler; then it becomes in appropriate for measurement of utility. 4.Diminishing marginal utility:The utility obtained from successive units of a commodity diminishes. Hermann Heinrich Gossen was the first to formulate this law in 1854 it is known as the“Gossen’s first law”. 5) Additivity:The total utility of a basket of goods depends on the quantities of the individual commodity. If there are‘n’commodities in the bundle with quantities X1, X2…….Xn, U=f (X1, X2………..Xn) In the early version of the demand theory or theory of consumer behavior it was assumed that the total utility is additive. U= U 1(X1) U2(X2)….. Un(Xn) But the additivity assumption was dropped in the later version of the cardinalist approach Additivity implies that independent utilities of the various commodities in the bundle, an assumption clearly unrealistic and not necessary for the cardinal theory. Equilibrium of the Consumer Condition for the equilibrium MUx=Px If MUx>Px,the consumer can increase welfare by purchasing more of x commodities IfMUx
Posted on: Wed, 19 Mar 2014 20:40:03 +0000
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