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Consumer Behaviour - Ordinal Utility Theory Revised

Ordinal utility theory addresses criticisms of cardinal utility theory by focusing on preferences rather than measurements. It assumes consumers can rank their preferences for bundles of goods based on the utility or satisfaction derived, but cannot quantify utility. Indifference curves are used to represent combinations of goods that provide equal utility. They have properties like being downward sloping and convex. The marginal rate of substitution measures the rate at which a consumer is willing to trade one good for another along an indifference curve.

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Abhishek Patil
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172 views

Consumer Behaviour - Ordinal Utility Theory Revised

Ordinal utility theory addresses criticisms of cardinal utility theory by focusing on preferences rather than measurements. It assumes consumers can rank their preferences for bundles of goods based on the utility or satisfaction derived, but cannot quantify utility. Indifference curves are used to represent combinations of goods that provide equal utility. They have properties like being downward sloping and convex. The marginal rate of substitution measures the rate at which a consumer is willing to trade one good for another along an indifference curve.

Uploaded by

Abhishek Patil
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Ordinal Utility Theory

Criticisms of Cardinal Utility Theory


• Utility is subjective
• Cardinal utility of measurement is not possible
• Every commodity/good is not an independent commodity/good,
ignored cross effect
• Marginal utility cannot be estimated in all conditions
• Marginal utility of money does not remain constant,
• Demand curve is derived based on ceteris and paribus condition
assumption. Therefore ignores income and substitution effects
• Lack of evidence of law of diminishing marginal utility
• Man is not calculating machine or a computer
Ordinal Utility Theory
• The Ordinal Utility approach is based on the fact that the utility of a
commodity cannot be measured in absolute quantity, but however, it
will be possible for a consumer to tell subjectively whether the
commodity derives more or less or equal satisfaction when compared
to another.
• The modern economists have discarded the concept of cardinal utility
and instead applied ordinal utility approach to study the behavior of
the consumers. 
• The modern economist, Hicks, in particular, have applied the ordinal
utility concept to study the consumer behavior. He introduced a tool of
analysis called “Indifference Curve” to analyze the consumer
behavior. An indifference curve refers to the locus of points each
showing different combinations of two substitutes which yield the
same level of satisfaction and utility to the consumer.
Assumptions of Ordinal Utility theory
• Consumer is a rational
• Consumer preferences are based on utility
• Consumer is able to rank his preferences
• Two goods/commodity
• Non-satiety: theory assumes that the consumer has not reached the point
of satiety. It implies that the consumer still has the willingness to consume
more of both the goods
• If two bundles have same utility, we say that the consumer is indifferent
• Among two bundles, the one with higher utility is preferred bundle …more
is preferred to less
• Preferences are transitive, if Bundle-A > Bundle-B and Bundle-B > Bundle-
C, then Bundle-A is preferred to Bundle-C (A>C)
• Diminishing Marginal Rate of Substitution
Main Front
Combination Camera Camera RAM Storage Price Utility
A 48 MP 24 MP 4 GB RAM 32 GB 25000 5
B 24 MP 48 MP 4 GB RAM 32 GB 25000 5
C 12 MP 24 MP 8 GB RAM 64 GB 25000 5
D 12 MP 16 MP 8 GB RAM 128 GB 25000 5
E 12 MP 16 MP 12 GB RAM 128 GB 25000 5
Hamburgers
  (X) Soft drinks
A 1 14 100
B 2 9 100
C 3 6 100
D 4 4 100
E 5 3 100
  Mangoes Oranges Utility
A 1 14 10
B 2 9 10
C 3 6 10
D 4 4 10
E 5 3 10
  Mangoes Oranges Utility
A 1 14 10
B 2 9 10
C 3 6 10
D 4 4 10
E 5 3 10

Hamburgers (X) New Soft drinks Utility


1 28 20
2 18 20
3 12 20
4 8 20
5 6 20
The marginal rate of substitution (MRS)
The marginal rate of substitution
(MRS) is the quantity of one good that
a consumer can forego for additional
units of another good at the same
utility level.
MRS is one of the central tenets in the modern
theory of consumer behavior as it measures the
relative marginal utility.
Marginal rates of substitutions are similar at
equilibrium consumption levels and are
calculated between goods bundles at indifference
curves. Combinations of two different goods that
give consumers equal utility and satisfaction can
be plotted on a graph using an indifference curve.
The MRS is based on the idea that changes in two
substitute goods do not alter utility whatsoever.
Δ Qty of
Δ Qty of Orange MRS of MUm/
  Mangoes Oranges Utility MU(o) MU(m) mangos s M for O MUo
A 1 14 10 1 13.00     ΔO/ΔM   
B 2 9 10 2 -10.00 1 -5 -5 -5
C 3 6 10 3 -9.00 1 -3 -3 -3
D 4 4 10 4 -8.00 1 -2 -2 -2
E 5 3 10 5 -5.00 1 -1 -1 -1
Examples - substitutes
Food Items Non Food items
Food Clothing
Mangoes Apples
Biscuits Samosa
Study Hours Entertainment
Health Insurance Life insurance
Stylish Performance
Skilled Labor Unskilled Labor
Examples – complementary goods
Cigarette and (Coffee/Tea)
Cigarette and Cool drink
DVD player and DVD disks
Tennis balls and tennis rackets.
iPhone and Apps
Scooter and Helmet
Car and Petrol
Left Shoe and Right Shoe, Shoes and Insoles
Pencils and Notebooks
Mobile Phone and SIM card
Indifference
curve for
complementary
goods
Indifference curve - Examples
Examples for High substitutability :
Coffee and Tea
Coke and Pepsi
Apple Juice and Orange Juice
Examples for almost perfect substitutes:
Bonds and Cash
500 rupee note & 50 rupee notes 10
Commercial Space vs Residential space
Gold ETFs vs Gold Bars
Bonds vs Equity
Properties of Indifference Curves
• Indifference curves are downward slopping
• Higher indifference curve represents higher utility/level of satisfaction
• Indifference curves never intersects
• Indifference curves are convex to the origin
• Indifference curve need not be a parallel to each other
• Higher indifference curve is always preferred to a lower one

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