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Nirig' of American History

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QN:A We all know that consumer is the one who uses goods and services to satisfy his/her wants.

She /he is assumed to be rational meaning that he/she earns at utility maximization, giving his/her income and commodity prices.

There several theories that have been developed to try and explain the behavior of a consumer, however they can be categorized in to two:

 Cardinal utility theory:- it argues that a consumer has the capacity to measure the level of satisfaction that she derives from consumption of a given quantity of a commodity.

 Ordinal utility theory:- it argues that a consumer cannot measure satisfaction numerically or subjectively instead she can rank the different baskets or bundles so as to choose the best basket.

Difference between cardinal and ordinal utility

The basic concept in this approach is utility which refers to satisfy power that a good or service consumed possesses in this approach, it is assumed that a consumer assigns a cardinal major which can be counted .

This means that a consumer can tell exactly how much satisfaction she can derive from consumption of a certain goods.

The theory assumes a cardinal measure in units called utils, using an instrument called utilometer ,however some economics have suggested that utility can be measured in monetary units by the amount of money offered for a commodity.

On the other hand the ordinal utility approach which argues that a consumer can't measure satisfaction numerically or subjectively.

The ordinal utility is also commonly known as indifference curve theory because its analysis is based on on indifference curve.

Indifference curves are psychological levels of satisfaction hence are more hypothical then real.

differences between these two theory are The major:-

1. In ordinal utility theory , the consumer can't be measured numerically the level of satisfaction derived from consumption of a good but can instead arrange or rank the difference baskets of goods basing on the quantities contained in each and their satisfy power with assumption that goods are homogeneous .

The consumer assumed to have the ability to rank the different combinations in such way that he chooses the great satisfy power.

While cardinal utility is measured in monetary terms or in utils and it is measurable and quantitative where as ordinal is not measurable and is qualitative.

2. Ordinal utility factions are unique up to positive monotone transformations while cardinal utilities are also unique up to positive linear transformations.

3. Utility functions of both sorts assign a ranking to member of a choice set. For example suppose a cup of orange juice has utility of 120 utils , a cup of tea has a utility of 80 utils , and a cup of water has a utility of 40 utils when speaking of cardinal utility , it could be concluded that the cup of orange juice is better than the cup of tea by exactly the same amount by which the cup of tea is better than the cup of water. One is not entitled to conclude however , that the cup of tea is two third as good as the cup of juice , because this conclusion would be depend on not only on magnitudes of utility differences but also on the zero of utility.

It is temping when dealing with cardinal utility to aggregate utilities across persons . the argument against this is that interpersonal comparisons utility are meaningless because there is no good way to interpret how different people value consumption bundles.

But when ordinal utility are used difference in utils are treated as ethically or behaviorally meaningless: the utility index encode a full behavioral ordering between members of a choice set, but tells nothing about the related strength of preferences. In the above example ,it would only be possible to say that juice is preferred to tea to water, but no more.

QN:B Assumption of Ordinal Utility

The ordinal utility approach to consumer behavior is built on the following assumption;-

i. Ordinal Utility is meaning that , a consumer can arrange her preferences according to the order of satisfaction that she /he derives from each basket , she /he does not need to know exactly the amount of satisfaction which she /he derive from each basket instead what is necessary is to know the satisfying power of each basket. For instance a consumer can say precisely that basket A gives her more satisfaction than B with out requiring her to measure numerically the amount of satisfaction.

ii. A consumer is assumed to be rational this means that she aims at maximizing satisfaction given her income and the commodity prices and will always choose the basket that gives her the greatest level of satisfaction.

iii. The theory assumes consumption of at least two commodities.

iv. That total utility of a consumer depends on the different quantities consumed by her that is U=U(x1.x2...xn) where 1,2......n are the n commodities.

v. It assumes diminishing marginal rate of substitution the slope of an indifference curve is known as marginal rate of substitution (MRS) and it shows the rate at which the consumer is willing to substitute commodity say X for other good Y.

vi. It assumes consistency and transitivity . by consistency we mean that if the consumer prefers combination A to B in one situation then she /he should not prefer B to A in other situation when A is still available otherwise she would be in consistency in her choice in other word if A >B B A on the other hand transitivity means that if the consumer prefers A to B and yet she prefers B to A then it would imply that she A to C i.e. if A>B and B>c A>.C.

QN:C Deriving and illustrating a demand curve using The ordinal utility approach .

there are points of tangency when price changes within a certain range. These points of tangency give the different amounts of quantity bought on a certain price range.

The relation between the price range and the quantity demanded constitutes



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