Unit No.

2- Demand Analysis

Lesson No.-8 Utility Approaches to the Theory of Demand

Learning Outcomes

After reading this lesson you should-

Understand various approaches to the theory of demand.
Understand the chief characteristics of ordinal and cardinal approach.
Distinguish between ordinal and cardinal approach.
Analyze the demand structure based on Cardinal approach.
Prepare a schedule to indicate the Law of Diminishing Marginal Utility.
Derive demand curve by Cardinal Approach.

Introduction

Students, in the last lesson we has seen the Law of Demand. ‘What does
it state?’ It states the inverse relation between the price of a commodity and its
quantity added. This Law of Demand was been explained by various economist
in their own ways. These explanations are known as the approaches to explain
the Law of Demand .

Approaches

Cardinal Ordinal Pragmatic

(by Marshall) (by Hicks) App. to DD analysis

Both these approaches states that the demand for any product is based
on the utility of that commodity. However, there are certain fundamental
differences. Before going into the differences let’s understand both the
approaches first.
Cardinal Approach

This is a traditional approach and examines the consumer behaviour

solely on the utility consideration. (For basic terms read appendix)

Law of Diminishing Marginal Utility :

It states that “Other things remaining the same, as a consumer

increases his consumption of goods, the Marginal Utility eventually starts
declining”.
Suppose, you are extremely thirsty, a glass of water certainly will have a
high Marginal Utility. However, after 2 or 3 glasses of water the Marginal Utility
inevitably starts falling and Marginal Utility of 5 or 6 glasses of water at a time
may prove to be negative.

Utility schedule :

Quantity T.U. M.U.

2 8 ---

3 18 10

4 26 8

5 31 5

6 33 2

7 33 0

8 32 -1

Activity:-
Draw T.U. and M.U. curves taking quantity on x-axis.

Derivation of DD curve -
Demand curve can be derived TU from MU curve. According to
the diagram given below , MU curve starts at point A and becomes negative at
point D. The lower panel suggests that for 2 units the buyer is ready to buy at Rs.
10/-. However, as the MU falls the buyer’s willingness reduces to buy the
commodity reduces resulting into decline in the price.

Diagram
(P.T.O.)
TU, MU
TU

C
D
Qty
MU
D
Price

Qty

Demand curve can be derived TU from MU curve. According to the

diagram MU curve starts at point A and becomes negative at point D. The lower
panel suggests that for 2 units the buyer is ready to buy at Rs. 10/-. However, as
the MU falls the buyer’s willingness reduces to buy the commodity reduces
resulting into decline in the price.

Limitations

• It is based on the unrealistic assumption of cardinal measurement of utility.

Utility is a psychological term which can not be measured in terms of numbers
and units.

• It is applicable only for one commodity.

• It does not explain the impact of the complementary and substitute goods on
the demand.
• It can not explain the impact of changes in the income on demand.

Activity: -
Analyse and list some more limitations of this approach.

Ordinal Utility Approach

In order to overcome the limitations of the cardinal utility approach Hick

gave a new treatment to the theory of demand.
According to this approach instead of measuring the utility in terms of the
number, given a choice from the “basket of commodities” a consumer can rank
the commodities according to their preferences. The higher order of preference is
given to the commodity which will give a higher utility. Thus this theory is also
know as the ‘revealed preference theory’.
This approach is explained with the help of “indifference curve analyis”.

1) Indifference curve

Indifference curve is the focus of points at which the combination of goods

gives the same amount of utility (level of satisfaction). For e.g. – if I am
consuming two commodities, viz. mangoes and oranges.

Schedule:

Combination Mangoes Oranges

1 10 2

2 8 3

3 6 4

4 4 5

5 2 6
Diagram:

Com Y

IC

Com X

All the above combinations will give me same level of utility. Whether I
consume 10 mangoes and 2 oranges or 6 mangoes and 4 oranges, my level of
satisfaction is the same.
Naturally the consumer is different in any of these combinations. That is
why the above downward sloping curve is known as the “indifference curve”.

2) Budget Line

The amount of goods a consumer can buy is constrained by the income.

This budgetary constraint can be shown by the budget line.
Suppose, I have Rs. 100/- to spend on buying fruits. I may buy mangoes
or oranges.
Pm = Price of mangoes = Rs. 20/-
Po = Price of oranges = Rs. 10/-

(Pm x Qm) + (Po x Qo) = Total Income

20 x5 10 x 0 100

20 x4 10 x 2 100

20 x3 10 x 4 100

20 x2 10 x 6 100

20 x1 10 x 8 100
Diagram

According to the above Table we can buy any of the combinations. 4

mangoes and 2 oranges or 2 mangoes and 6 oranges will result into complete
utilization of my budge

Qty of O

Qty of M

According to the above Table I can buy any of the combinations. 4

mangoes and 2 oranges or 2 mangoes and 6 oranges will result into complete
utilisation of my budget.

Consumer equilibrium

Diagram

The consumer is in the equilibrium where the indifference curve is

tangent to the budget line.
According to the diagram given below, the equilibrium is at point E.

Qty of O

C F
E
IC 3
IC 2
D IC 1

Qty of M
Activity:-
Analyse why C, D or F point are not the point of equilibrium.
Points to pointer
Slide 1 ___________________________________
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Why do you need a commodity
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A commodity is needed because
of the following reasons:
to satisfy our want
To have happiness
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To have pleasure

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Slide 2 ___________________________________
Meaning of utility ___________________________________
it’s a want satisfying capacity of a commodity ___________________________________
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Slide 3 ___________________________________
Utility approaches ___________________________________
two types of utility approaches: ___________________________________
Cardinal approach
Ordinal approach
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Slide 4
Cardinal approach
its based on the assumption of the cardinal
measurement of utility.
Its coined by neo-classical economist
“Marshall”.
Slide 5
ordinal approach
Its coined by modern economist “J.R HICKS”
Based on the assumption of ranking of utility
according to the preferences.
Example: more than, less than, equals to,
etc.
Slide 6
Difference between cardinal and
ordinal approaches
Difference between cardinal approach and
ordinal is that “according to cardinal
approach utility can be measurable in
numeric terms and according to the ordinal
utility can’t be measurable in numeric terms .
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