The Ordinal Approach To Utility Analysis

The Ordinal Approach to Utility Analysis:
Indifference Curve Approach
Limitations of Cardinal Approach to Utility Analysis:

Concept of Indifference Curve:
Graphical presentation:
Assumptions of Ordinal utility analysis
Definition and Properties of an Indifference curve:
The Budget Constraint or Budget Line or Price Line:
AND
Consumer equilibrium
The limitations of the cardinalist approach to utility analysis
1. Subjective units for the measurement of utility does not provide any satisfactory
solution
2. The assumption of Constant utility of money is also unrealistic
Utility cannot be measured in any absolute sense. We cannot really say, therefore, by how
much the marginal utility of one good exceeds another. An alternative approach is to use
indifference analysis. This does not involve measuring the amount of utility a person
gains, but merely ranking various combinations of goods in order of preference. In other
words, it assumes that consumers can decide whether they prefer one combination of
goods to another.
The aim of indifference analysis, then, is to analyse, without having to measure utility,
how a rational consumer chooses between two goods. Indifference analysis involves the
use of indifference curves and budget lines.
Indifference curves
An indifference curve shows all the various combinations of two
goods that give an equal amount of satisfaction or utility to a
consumer. In other words, Indifference curve represents a line
showing all those combinations of two goods between which a
consumer is indifferent: i.e. those combinations that give the same
level of utility. Indifference set A table showing the same
information as an indifference curve.
This table is known as an indifference set. It shows alternative combinations of two
goods that yield the same level of satisfaction. From this we can plot an indifference
curve.
MRS
--
An Indifference
curve
6:1
4:1
3:1
1.3:
1
1:1
.4:1
Assumptions of Ordinal Approach
i) Rationality: Consumers are sane and want to maximize total
utility given money income and prices of the commodities.
ii) Utility is Ordinal:

iii) Consistency and Transitivity:
iv) Diminishing marginal rate of substitution:
v) Total utility is a function of commodities:
A B C
ii) Utility is Ordinal

iii) There is consistency; that is, if the consumer is observed to prefer basket A to basket B,
then this consumer will never prefer B to A.
There is transitivity; that is, if A is preferred to B and B to C, then A is preferred to C.
iv) Marginal Rate of Substitution (MRS) is Diminishing
Defining MRS: The marginal rate of substitution of X for Y

(MRSxy) refers to the amount of Y that a consumer is willing to
give up in order to gain one additional unit of X (and still remain
on the same indifference curve). As the individual moves down an
indifference curve, the MRSxy diminishes.
Marginal rate of substitution (MRS) (between two goods in
consumption):
The amount of one good (Y) (pear) that a consumer is prepared to give up in
order to obtain one extra unit of another good (X) (orange): i.e. ΔY/ΔX.
Diminishing marginal rate of substitution (MRS): The more a person

consumes of good X and the less of good Y, the less additional Y will that
person be prepared to give up in order to obtain an extra unit of X: i.e.
ΔY/ΔX diminishes.
The reason for a diminishing marginal rate of substitution is related to the

principle of diminishing marginal utility
The relationship between the marginal rate of substitution and
marginal utility:
In the above Figure, consumption at point a yields equal
satisfaction with consumption at point b. Thus the utility sacrificed
by giving up 6 pears must be equal to the utility gained by
consuming one more orange. In other words, the marginal utility of
an orange must be six times as great as that of a pear. Therefore,
MU of oranges /MU of pears = 6. But this is the same as the
marginal rate of substitution. With X measured on the horizontal
axis and Y on the vertical axis, then:
MRS = (MUX / MUY ) = the slope of indifference curve (ignoring
negative sign)
Properties of an Indifference curve
1. Downward sloping to the right
2. A higher indifference curve (IC) shows a greater amount

of satisfaction and a lower one, less satisfaction. Thus,
indifference curves show an ordinal rather than a cardinal
measure of utility.
3. Indifference curves do not intersect each other
4. Indifference curves are convex to the origin

The following Table gives points on four different indifference curves for a consumer.
(a) Sketch indifference curves I, II, III, and IV on the same set of axes. (b) What do
indifference curves show?
b) In difference curves are a graphic picture of a consumer’s tastes and
preferences (in utility analysis, the consumer’s total utility curve introduced
the tastes of the consumer). The consumer is indifferent among all the
different combinations of X and Y on the same indifference curve but prefers
points on a higher indifference curve to points on a lower one. Even though
we have chosen to represent a consumer’s tastes by sketching only 3 or 4
indifference curves here, the field of indifference curves is dense (i.e., there
are an infinite number of them). All the indifference curves of a consumer
give us the consumer’s indifference map. Different consumers have different
indifference maps. When the tastes of a consumer change, that person’s
indifference map changes.
INDIFFERENCE MAP
More than one indifference curve can be drawn on a graph where
each successive indifference curve shows a higher level of utility.
Combinations of goods along IC-2 in the figure give a higher
utility to the consumer than those along IC-1. Those along IC-3
give a higher utility than those along IC-2 , and so on.
Indifference map: A graph
showing a whole set of
indifference curves. The further
away a particular curve is from
the origin, the higher the level of
satisfaction it represents.
BUDGET LINE
Whereas indifference maps illustrate people’s preferences, the actual choices
they make depend on their incomes. The budget line shows what
combinations of two goods a consumer is able to buy, given (a) his/her
income available to spend on them and (b) their prices.
Budget line A graph showing all the possible combinations of two goods
that can be purchased at given prices and for a given budget.
Consumption Possibilities for Budget $30 and $40
A change in income :
If the consumer’s income (and hence budget) increases, the budget line will
shift outwards, parallel to the old one.
A change in price :
The relative prices of the two goods are given by the slope of the budget line.
Thus the slope of the budget line equals PX/PY. If the price of either good
changes, the slope of the budget line will change.
Budget Line Showing Income change (left) and price change (right)
The optimum consumption point
We are now in a position to put the two elements of the analysis
together: the indifference map and a budget line. This will enable us
to show how much of each of the two goods the ‘rational’ consumer
will buy from a given budget. The consumer would like to
consume along the highest possible indifference curve. This is
curve IC-3 at point t. Higher indifference curves, such as IC-4
and IC-5 , although representing higher utility than curve IC-3, are
in the infeasible region: they represent combinations of X and Y that
cannot be afforded with the current budget. The consumer could
consume along curves IC-1 and IC-2, between points r and v, and s
and u respectively, but they give a lower level of utility than
consuming at point t.
The optimum consumption point for the consumer, then, is where the
budget line touches (is ‘tangential to’) the highest possible
indifference curve. At any other point along the budget line, the
consumer would get a lower level of utility. If the budget line is
tangential to an indifference curve, they will have the same slope.
(The slope of a curve is the slope of the tangent to it at the point in
question.) But as we have seen:
The slope of the budget line = Px/Py and and the slope of the
indifference curve = MRS = MUx/MUy. Therefore, at the optimum
consumption point:
Px/Py = MUx/MUy
But this is the equi-marginal principle that we established in the first
part of this chapter: only this time, using the indifference curve
approach, there has been no need to measure utility. All we have
needed to do is to observe, for any two combinations of goods,
whether the consumer preferred one to the other or was indifferent
between them.
CONSUMER EQUILIBRIUM
What constraints or limitations does the consumer face in seeking to
maximize the total utility from personal expenditures? (b) Express
mathematically the condition for consumer equilibrium. (c) Explain the
meaning of your answers to part (b).
(a) In seeking to maximize the total utility from personal

expenditures, the consumer faces an income and price constraint or
limitation. That is, the consumer has a given and limited income
over a specific period of time and faces given and fixed prices of the
commodities he or she seeks to purchase (i.e., the individual
consumer is too small to affect market prices). Thus, given
individual income and price constraints, the rational consumer seeks
to maximize the total utility from expenditures.
(b) The condition for consumer equilibrium can be expressed
mathematically, as follows
MUx/Px = MUy/Py = . . . .
subject to the constraint that
PxQx + PyQy + . . . . = M (the individual’s money income)

(c) The above two expressions mean that the marginal utility
of the last dollar spent on X must be equal to the marginal
utility of the last dollar spent on Y and so on for all
commodities purchased, subject to the constraint that the
amount of money spent on X (PxQx) plus the amount of
money spent on Y (PyQy) plus the amount of money spent on
all other commodities purchased by this individual exactly
equals the individual’s money income (if we assume that the
total income is spent; i.e., if we assume that nothing is saved).
What is the relationship between the cardinal utility approach and the indifference curve
approach to consumer demand theory? (b) What is the basic difference between these
two approaches?
a) The indifference curve approach to the study of consumer demand theory can be used as an
alternative to the older utility approach for the purpose of analyzing consumer behavior (such
as equilibrium and exchange) and deriving a consumer demand curve for a commodity.
(b) The basic difference between the utility approach and the indifference curve
approach is that the utility approach rests on the stronger and somewhat
unrealistic assumption that utility is measurable in a cardinal sense, while the
indifference curve approach requires only an ordinal measure of utility or
satisfaction. That is, the indifference curve approach requires only that the
consumer be able to decide whether one basket of goods yields more, equal, or
less satisfaction than other baskets of goods, without the need to attach a specific
number of utils of utility to each basket.
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The Ordinal Approach to Utility Analysis:

Indifference Curve Approach

Limitations of Cardinal Approach to Utility Analysis:

ii) Utility is Ordinal:

ii) Utility is Ordinal

There is transitivity; that is, if A is preferred to B and B to C, then A is preferred to C.

iv) Marginal Rate of Substitution (MRS) is Diminishing

Defining MRS: The marginal rate of substitution of X for Y

Diminishing marginal rate of substitution (MRS): The more a person

The reason for a diminishing marginal rate of substitution is related to the

1. Downward sloping to the right

2. A higher indifference curve (IC) shows a greater amount

3. Indifference curves do not intersect each other

4. Indifference curves are convex to the origin

(a) In seeking to maximize the total utility from personal

subject to the constraint that

PxQx + PyQy + . . . . = M (the individual’s money income)

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