Ordinal Utility Analysis 3

ORDINAL
UTILITY
ANALYSIS
Unit 4
Slide 3
ORDINAL UTILITY
ANALYSIS
 Cardinal utility gives a value of utility to
different options. Ordinal utility just ranks in
terms of preference.
 In ordinal utility, the consumer only ranks
choices in terms of preference but we do not
give exact numerical figures for utility.
 For example in cardinal utility analysis we can
say that we got 5 utils of utility from the
consumption of an apple and 8 utils from a
mango but in ordinal uility analysis we can
say we got more utility from the consumption
of mango but can’t say by how much.
 In other words we can prefer mango to apple.
ORDINAL UTILITY
ANALYSIS
 The technique of indifference curves was
originated by Francis Y. Edgeworth in England
in 1881. It was then refined by Vilfredo Pareto,
an Italian economist in 1906. This technique
attained perfection and systematic application
in demand analysis at the hands of Prof. John
Richard Hicks and R.G.D. Allen in 1934.
 Hicks and Allen criticized Marshallian cardinal
approach of utility and developed indifference
curve theory of consumer’s demand. Thus, this
theory is also known as ordinal approach.
 The concept of ordinal utility analysis can be
measured with the help of indifference curve
analysis.
ORDINAL UTILITY
ANALYSIS
 Indifference curve: Indifference
curve explains consumer’s behavior
in terms of his preference or
ranking for different combinations
of two goods say X and Y.
 Indifference curve is a locus of points
each representing a different
combinations of two goods giving
the same level of satisfaction or
utility.
ORDINAL UTILITY
ANALYSIS
 Each point of indifference curve gives the same
level of satisfaction so the consumer is indifferent
between any combinations of goods
 In this concept a consumer can substitute goods
 This curve is also called as iso-utility curve or
equal utility curve.
 Assumptions:
 i. Rationality:
 Implies that a consumer is a rational being and
aims at maximizing the total satisfaction given the
income and prices of goods and services.
 ii. Ordinal Utility:
 Assumes that utility is expressible only in ordinal
terms. This implies that a consumer is only able to
express his/her preference for goods.
 iii. Transitivity and Consistency of Choice:
 Implies that consumer choices are assumed to be
transitive and consistent. The transitivity of
choice means that if a consumer prefers A to B
and B to C, he/she would prefer A to C. On the
other hand, the consistency of choice means that
if a consumer prefers A to B in one period, he or
she cannot prefer B to A in another period.
 iv. Non-satiety:
 Implies that a consumer is assumed to be non-
satisfied. In other words, it is assumed that
consumer does not reach the level of satisfaction
by consuming a good and always prefers a large
quantity of goods.
ORDINAL UTILITY
ANALYSIS
 v. Diminishing Marginal Rate of
Substitution: Acts as an important
concept in indifference curve analysis.
Marginal rate of substitution implies the
rate at which a consumer is willing to
substitute one good (X) for another
good (Y), so that the total satisfaction
remains the same.
 MRS(x,y)= y/ X (diminishing)
 MRS(x,y)=marginal rate of substitution
 Y = change in consumption of Y good
 X = change in consumption of X good
ORDINAL UTILITY
ANALYSIS
combination Good X Good Y MRS (x,y)
s
A 1 12 -
B 2 8 4
C 3 5 3
D 4 3 2
E 5 2 1
Discribe the indifferent schedule.
ORDINAL UTILITY
ANALYSIS
Discribe the IC
ORDINAL UTILITY
ANALYSIS
 Indifference Map
 Indifference Map is a group of indifference curves
for two commodities showing different levels of
satisfaction.
 Or in other words , a graph showing a whole set of
indifference curves is called an indifference map.
 In this indifference map, it should be clearly
understood that a higher indifference curve
denotes higher level of satisfaction and a lower
indifference curve represents lower level of
satisfaction.
 Being rational, the consumer will always choose a
higher indifference curve to get maximum
satisfaction, other things being equal.
ORDINAL UTILITY
ANALYSIS
PROPERTIES OF
INDIFFERENCE CURVE
 There are four basic properties of an
indifference curve. These properties are:
1.Indifference curve slope downwards to
right:
 An indifference curve can neither be horizontal
line nor an upward sloping curve. This is an
important feature of an indifference curve.
 When a consumer wants to have more of a
commodity, he/she will have to give up some of
the other commodity, given that the consumer
remains on the same level of utility at constant
income. As a result, the indifference curve
slopes downward from left to right.
PROPERTIES OF
INDIFFERENCE CURVE
In the given diagram, IC is an
indifference curve, and A and B
are two points which represent
combination of goods yielding
same level of satisfaction. We
can see that when X1 amount
of commodity X was
consumed, Y1 amount of
commodity Y was also
consumed. When the
consumer increased the
consumption of commodity X
to X2, the amount of
commodity Y fell to Y2. And,
thus the curve is sloping
downward from left to right.
PROPERTIES OF
INDIFFERENCE CURVE
2. Indifference curve is convex to the origin:
 As mentioned previously, the concept of
indifference curve is based on the properties of
diminishing marginal rate of substitution.
 According to diminishing marginal rate of
substitution, the rate of substitution of
commodity X for Y decreases more and more
with each successive substitution of X for Y.
 Also, two goods can never perfectly substitute
each other. Therefore, the rate of decrease in a
commodity cannot be equal to the rate of
increase in another commodity.
PROPERTIES OF
INDIFFERENCE CURVE
combi Good Good MRS
nation X Y (x,y)
s
A 1 12 -
B 2 8 4
C 3 5 3
D 4 3 2
E 5 2 1
We can clearly see that the rate of decrease in consumption of

Y good is not the same as rate of increase in consumption of X
good . Similarly, rate of decrease in consumption of Y good has
gradually decreased even with constant increase in
consumption of X good.
Thus, indifference curve is always convex (neither concave nor
straight).
PROPERTIES OF
INDIFFERENCE CURVE
3. Higher indifference curve
represents higher level of
satisfaction
 Higher the indifference curves, higher
will be the level of satisfaction. This
means, any combination of two goods
on the higher curve give higher level of
satisfaction to the consumer than the
combination of goods on the lower
curve.
PROPERTIES OF
INDIFFERENCE CURVE
In the above figure, IC1 and
IC2 are two indifference
curves, and IC2 is higher than
IC1. We can also see that Q is
a point on IC2 and S is a point
on IC2.
Combination at point Q
contains more of both the
goods (X and Y) than that of
the combination at point S.
We know that total utility of
commodity tends to increase
with increase in stock of the
commodity. Thus, utility at
point Q is greater than utility
at point S, i.e. satisfaction
yielded from higher curve is
greater than satisfaction
yielded from lower curve.
PROPERTIES OF
INDIFFERENCE CURVE
4. Indifference curve cannot intersect
each other:
 Each indifference curve is a
representation of particular level of
satisfaction.
 The level of satisfaction of consumer for
any given combination of two
commodities is same for a consumer
throughout the curve. Thus, indifference
curves cannot intersect each other.
 The following diagram will help you
understand this property clearer.
PROPERTIES OF
INDIFFERENCE CURVE
In the above image, IC1
and IC2 are two
indifference curves and C
is the point where both the
curves intersect.
According to indifference
curve theory, satisfaction
at point C = satisfaction at
point A
Also, satisfaction at point
C = satisfaction at point B
But, satisfaction at point B
≠ satisfaction at point A.
Therefore, two indifference
curves cannot intersect.
Yet, two indifference
curves need not be
parallel to each other.
PROPERTIES OF
INDIFFERENCE CURVE
 5. 5. Indifference curves are not
necessarily parallel to each other:
 Indifference curve may be or may not be
parallel to each other, it depends on
marginal rate of substitution. If marginal
rate of substitution is same for two
indifference curves then the slope of
the curves would be same and the
curves would be parallel to each other.
But if marginal rate of substitution is
different then curves would be non–
parallel to each other.
PROPERTIES OF
INDIFFERENCE CURVE
Describe the figure.
PROPERTIES OF
INDIFFERENCE CURVE
6. Indifference curves never touches any
of the axis: Indifference curve do not touch
any of the axis, because if indifference curve
touches any of the axis then it would mean
that the quantity of one commodity becomes
zero
If indifference curve touches X axis then it
means that units of Y commodity becomes
zero and if indifference curve touches Y axis
then it means units of X commodity becomes
zero. As ordinal approach considers that
consumer is consuming two or more
commodities at a time so the IC doesn’t
touch any axes.
PROPERTIES OF
INDIFFERENCE CURVE
MARGINAL RATE OF
SUBSTITUTION
 The marginal rate of substitution is the rate of
exchange between some units of goods X and Y
which are equally preferred. The marginal rate of
substitution of X for Y (MRS)xy is the amount of Y
that will be given up for obtaining each additional
unit of X.
 In other words, Marginal rate of substitution (MRS)
may be defined as the rate at which the consumer
is willing to substitute one commodity for another
without changing the level of satisfaction.
 In other words, MRS can also be defined as the
amount of a commodity that a consumer is willing
to trade off for another commodity, as long as the
second commodity provides same level of utility as
the first one.
MARGINAL RATE OF
SUBSTITUTION
 If we denote two commodities as X and
Y, then MRS between X and Y can be
expressed as the amount of Y a
consumer is willing to give up so as
obtaining one more unit of commodity
X.
 Mathematically, MRS is represented as
 MRS=ΔY/ΔX
MARGINAL RATE OF
SUBSTITUTION
 Marginal rate of substitution (MRS) is based on an
important economic principle, i.e. MRS of X for Y
diminishes more and more with each successive
substitution of X for Y. This principle is known as
diminishing marginal rate of substitution.
 According to MRS, a consumer can let go off some
of one commodity, say Y, in order to gain more of
the other commodity X. However, as the consumer
starts getting more and more of commodity X, he
tends to forego less and less of good Y.
 The rate at which the consumer substitutes X for Y
is greater at the beginning. But, as he continues the
substitution process, the rate of substitution begins
to fall.
MARGINAL RATE OF
SUBSTITUTION
For table and figure ,see slide no 15
CAUSES FOR DIMINISHING
MARGINAL RATE OF SUBSTITUTION
 Goods are not perfectly substitutable: Goods can never
be perfectly substitutable. If one good can perfectly
substitute another good, both the goods are regarded as
same. And, thus, increase or decrease in amount of any
good will not cause effect in marginal substitution.
 Increase in one good does not increase the want
satisfying power of another good: Since two goods
cannot be perfectly substitutable, an increase in one good
cannot fully satisfy the consumer as the other good.
 The want for a particular commodity can be satiable:
According to marginal rate of substitution, a person can
sacrifice certain amount of one commodity (y) in order to
increase the stock of other commodity (X). He keeps on
sacrificing Y for X until the point of satiety, after which his
demand for X starts declining.
 Also, trading off Y more and more causes decrease in stock
of Y, to maintain which he is now willing to forego lesser and
lesser of that good with each successive increment of X.
SPECIAL CASES OF IC TO
KNOW
SPECIAL CASES OF IC TO
KNOW
CRITICISM OF ORDINAL UTILITY
ANALYSIS

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ORDINAL

We can clearly see that the rate of decrease in consumption of

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