5/7/2015

BBAStudyNotes:Utility:Cardinalutilityapproach,diminishingmarginalutility,lawofequimarginalutility,ordinalutilityapproach
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BBAStudyNotes
Wednesday,19June2013

Utility:Cardinalutilityapproach,diminishing
marginalutility,lawofequimarginalutility,
ordinalutilityapproach
Humanwantsareunlimitedandtheyareofdifferentintensity.Themeansatthedisposalofaman
arenotonlyscarcebuttheyhavealternativeuses.Asaresultofscarcityofrecourse,theconsumer
cannotsatisfyallhiswants.Hehastochooseastowhichwantistobesatisfiedfirstandwhich
afterwardiftherecoursepermit.Theconsumerisconfrontedinmakingachoice.
Forexample,amanisthirsty.Hegoestothemarketandsatisfyhisthirstbypurchasingcocacola
insteadoftea.Weareheretoexaminetheeconomicforceswhichmakehimpurchaseaparticular
commodity.Theanswerissimple.Theconsumerbuysacommoditybecauseitgiveshim
satisfaction.Intechnicalterm,aconsumerpurchasesacommoditybecauseithasutilityforhim.We
nowexaminethetoolswhichareusedintheanalyzesofconsumerbehavior.
ConceptofUtility:
Jevon(18351882)wasthefirsteconomistwhointroducestheconceptofutilityineconomics.
Accordingtohim:
"Utilityisthebasisonwhichthedemandofaindividualforacommoditydependsupon".
Utilityisdefinedas:
"Thepowerofacommodityorservicetosatisfyhumanwant".
Utilityisthusthesatisfactionwhichisderivedbytheconsumerbyconsumingthegoods.
Forexample,clothhasautilityforusbecausewecanwearit.Penhasautilitywhocanwritewith
it.Theutilityissubjectiveinnature.Itdiffersfrompersontoperson.Theutilityofabottleofwineis
zeroforapersonwhoisnondrinkerwhileithasaveryhighutilityforadrinker.
Hereitmaybenotedthatthetermutilitymaynotbeconfusedwithpleasureorunfullnesswhicha
commoditygivestoanindividual.Utilityisasubjectivesatisfactionwhichconsumergetsfrom
consuminganygoodorservice.
Forexample,poisonisinjurioustohealthbutitgivessubjectivesatisfactiontoapersonwhowishes
todie.Wecansaythatutilityisvalueneutral.

AssumptionsofCardinalUtilityAnalysis:

Themainassumptionorpremisesonwhichthecardinalutilityanalysisrestsareasunder.

(i)Rationality.Theconsumerisrational.Heseekstomaximizesatisfactionfromthelimitedincome
whichisathisdisposal.

(ii)Utilityiscardinallymeasurable.Theutilitycanbemeasuredincardinalnumberssuchas1,3,
10,15,etc.Theutilityisexpressedinimaginarycardinalnumberstellsusagreatdealaboutthe
preferenceoftheconsumerforagood.

(iii)Marginalutilityofmoneyremainsconstant.Anotherimportantpremiseofcardinalutilityof
moneyspentonthepurchaseofagoodorserviceshouldremainconstant.

(iv)Diminishingmarginalutility.Itisalsoassumedthatthemarginalutilityobtainedfromthe
consumptionofagooddiminishescontinuouslyasitsconsumptionisincreased.

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BBAStudyNotes:Utility:Cardinalutilityapproach,diminishingmarginalutility,lawofequimarginalutility,ordinalutilityapproach

(v)Independentutilities.AccordingtotheCardinalistschool,theutilitywhichisderivedfromthe
consumptionofagoodisafunctionofthequantityofthatgoodalone.Ifdoesnotdependatallupon
thequantityconsumedofothergoods.Thegoods,wecansay,possessindependentutilitiesandare
additive.

(vi)Introspectionmethod.TheCardinalistschoolassumesthatthebehaviorofmarginalutilityin
themindofanotherpersoncanbejudgedwiththehelpofselfobservation.Forexample,Iknowthat
asIpurchasemoreandmoreofagood,thelessutilityIderivedfromtheadditionalunitsofit.By
applyingthesameprinciple,Icanreadotherpeoplemindandsaywithconfidencethatmarginal
utilityofagooddiminishesastheyhavemoreunitsofit.
Criticism:

Pareto,anItalianEconomist,severelycriticizedtheconceptofcardinalutility.Hestatedthatutility
isneitherquantifiablenoraddible.Itcan,howeverbecompared.Hesuggestedthattheconceptof
utilityshouldbereplacedbythescaleofpreference.HicksandAllen,followingthefootstepsof
Pareto,introducedthetechniqueofindifferencecurves.Thecardinalutilityapproachisthusreplaced
byordinalutilityfunction.

equimargtinalutility

Itisthedesireofeveryconsumerthathewantstogetmaximumsatisfactionfromhislimited
resources.Hecansolvethisproblemifhespendshisincomeinsuchawaythatthelastrupee
spentoneachitemgiveshimthesameamountofsatisfaction.Itiscalledthelawofequimarginal
utility.
R.G.LipseySays,"Thehouseholdmaximizingisutilitywillallocatehisexpendituresbetween
commoditiesinsuchawaythattheutilityofthelastpennyspentoneachisequal."
Everyconsumerwillsubstitutethemoreusefulforthelessusefulthing.Thislawisalsoknownas
thelawofsubstitution.ItiscalledthelawofEquiMarginalUtilitybecauseitisonlylawbywhichthe
marginalutilitieshavebeenequalizedthroughtheprocessofsubstitution.Thislawcanbeexplained
withthehelpoffollowingschedule,assumingthatourconsumerhasonlyRs.5/tospend.Furtherit
isassumedthattherearetwocommoditiesAppleandOrange.

AccordingtothisscheduleifoneconsumerspendshisRs.5/ononethingthenhewillgetonly30
or20unitsofsatisfaction.TogetmaximumsatisfactionaconsumerwillspendRs.3/onAppleand
Rs.2/onOrange.Becauseinthiswaythetotalamountofutilitywillbemaximum.
WhenaconsumerwillspendRs.3/onApplehewillget=10+8+6=24
ByspendingtworupeesonOrangeshewillget=8+6=14
Totalamountofsatisfactionwillbe24+14=38
Ifhewilladoptanyothermethod,hewouldnotgetsuchamountofutility.Sowefindthatwhenthe
marginalutilities(6=6)areequalthetotalutilityismaximum.Nocombinationwillgivehimmore
satisfactionexceptthisone.

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BBAStudyNotes:Utility:Cardinalutilityapproach,diminishingmarginalutility,lawofequimarginalutility,ordinalutilityapproach

EXPLANATION:InthisdiagramMM'isthemarginalutilitycurveofApple.IfconsumerspendsRs.
3/onApple.The3rdrupeesutilityisFG,KK'themarginalutilitycurveoforange.Thelastrupee
utilityisHJ.BoththemarginalutilitiesFG=HJ.
LIMITATIONSOFTHELAWOFEQUIMARGINALUTILITY
1.Unmeasurableconcept:
Theconceptofutilityisunmeasurablesoitisverydifficulttobehaveaccordingtothelaw.
2.Carelessness:
Sometimesduetoignorancepeopledonotobtainthemaximumadvantagebyequatingthemarginal
utilities.
3.Indivisibleunits:
Iftheunitofexpenditureisindivisiblethenthislawwillnotoperate.
4.Customs:
Peopleareslaveofcustomsandtraditions,sotheyusethegoodslikegoldeventhereislessutility.
5.Freedomofchoice:
Ifthereisnoperfectfreedomtochoosebetweenvariouscommodities,thenthelawwillnotoperate

OrdinalUtilityApproach:
Thebasicideabehindordinalutilityapproachisthataconsumerkeepsnumberofpairsoftwo
commoditiesinhismindwhichgivehimequallevelofsatisfaction.Thismeansthattheutilitycanbe
rankedqualitatively.
Theordinalutilityapproachdiffersfromthecardinalutilityapproach(alsocalledclassicaltheory)in
thesensethatthesatisfactionderivedfromvariouscommoditiescannotbemeasuredobjectively.
Ordinaltheoryisalsoknownasneoclassicaltheoryofconsumerequilibrium,Hicksiantheoryof
consumerbehaviour,indifferencecurvetheory,optimalchoicetheory.Thisapproachalsoexplains
theconsumer'sequilibriumwhoisconfrontedwiththemultiplicityofobjectivesandscarcityofmoney
income.
Theimportanttoolsofordinalutilityare:
1. Theconceptofindifferencecurves.
2. TheslopofI.C.i.e.marginalrateofsubstitution.
3. Thebudgetline.
Theordinalutilityapproachisbasedonthefollowingassumptions:
1. Aconsumersubstitutescommoditiesrationallyinordertomaximizehislevelofsatisfaction.
2. Aconsumercanrankhispreferencesaccordingtothesatisfactionofeachbasketofgoods.
3. Theconsumerisconsistentinhischoices.
4. Itisassumedthateachofthegoodisdivisible.
5. Itisassumedthattheconsumerhasfullknowledgeofpricesinthemarket.
6. Theconsumer'sscaleofpreferencesissocompletethatconsumerisindifferentbetween
them.
7. Twocommoditiesareusedbytheconsumer.Itisalsoknownastwocommoditiesmodel.
8. TwocommoditiesXandYaresubstitutesofeachother.Thesecommoditiescanbeeasily
substitutedinvariouspairs.

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Approach (1) net present value (1) Net Present Value
Calculations (1) Network Communication Devices BBA 2
Semester(1)NetworkProtocol(TCP/IP).BBA2Semester
(1) Network topologies (1) Network types (1) new product
development marketing management (1) Nominal and
Real Value of Money (1) Non comparative scaling
techniques(1)NonVerbalCommunicationActionsSpeak
Louder than Words (1) Nonprofit Organization (1) Notice
writingBBA2Semester (1) Objectives and Importance (1)
ObjectivesofAccounting(1)ObjectivesOfCostAccounting
(1) Objectives of DBMS (1) Objectives of Inventory
Management (1) Objectives of Management (1)
observation methods and survey method (1) Obstacles in
ManpowerPlanning(1)Offerandacceptance(1) Oligopoly
(1) Operating Cash Flow to Sales Ratio (1) Opportunity
CostofCapital(1)Optimumfirm (1) Oral Communication
Meaning (1) Order Letter BBA 2 Semester (1) Ordinary
Annuity vs. Annuity Due (1) organisation behavior (3)
Organizational Leadership (1) Organizing Function and its
importance (1) Orientation and Placement (1) Origin of
Transactions Source Documents and Vouchers (1)
OUTPUTEMPLOYMENT THEORIES (CLASSICAL AND
KEYNESIAN) (1) Overcoming Communication Barriers
management (1) Overhead (1) overhead absorption (1)
OverheadCostAllocation(1)OverviewofPhonetics(1)P/V
Ratio (1) Packaging Marketing management (1) Page
Formatting (1) paint brush (1) Perception Management in
Human Resource Development (HRD) (1) Perfect
competition (1) performance and discharge of contract (1)
Performance Appraisal (1) Performance Appraisal Biases
(1) Performance Appraisal Interview (1) Performance
Appraisal Process (1) Performance Appraisal Tools and
Techniques (1) Performance Management as a HR
Management concept (1) Performance Management in
Successful Companies (1) Personal Factors affecting
ConsumerBehaviour(1)PersonalityAsaKeyConceptin
Human Resource Development (HRD) (1) Personnel
Management (15) Personnel Records (1) Physical
communication media. BBA 2 Semester (1) Physical
distribution marketing management (1) planning (1)
PLANNING CURVE: (1) Planning Function of
Management (1) POM (13) portfolio management
(9) Portfolio Management Meaning and Important
Concepts (1) Portfolio Management Models (1) Portfolio
RevisionMeaning(1)Positioning marketing management
(1)PostingJournalEntriestoLedgerAccounts (1) pre and
post testing (1) precis making BBA 2 Semester (1)
PreparationofManufacturing(1)PresentValueandFuture
Value of Money (1) price discrimination (1) Price Earnings
Growth(PEG)Ratio(1)Priceelasticityofdemand(PED)(1)
PricetoBookValueRatio(1)Price to Cash Flow Ratio (1)
Price to Earnings (PE) Ratio (1) Price to Sales Ratio (1)
pricing(1)primary(1)Principles of Delegation (1) Principles
ofManagement(1)PrinciplesofManagerialEconomics (1)
Principles of Organizing (1) Principles of Scientific
Management(1)Probability(1)Probability:TypesofEvents
(1) procedure of assessment (1) Process of Controlling (1)
process of research (1) Processes in Human Resource
Management(1)productdefinitionmarketingmanagement
(1) Product life cycle marketing management (1) product
promotion marketing management (1) Production and
Operations Management (10) Production and
OperationsManagementitsfunctions(1) Production in the
Shortrun&Longrun(1) PRODUCTION PLANNING AND
CONTROL(1)ProfitMaximizationCriticisms (1) Proprietary
Ratio(1)Provision and Reserves (1) Psychological Factors
affecting Consumer Behaviour (1) Purposes for Listening

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BBAStudyNotes:Utility:Cardinalutilityapproach,diminishingmarginalutility,lawofequimarginalutility,ordinalutilityapproach
BBA 1 Semester (1) Put Call Ratio Formula (1) Qualities
of a Leader (1) Quality (1) Quality Circles (1) Quantity
theory of money (1) Quasi Rent (1) Queries in a DBMS
BBA 2 Semester (1) Querying: creating (1) Questionnaire
(1)QuickRatioMeaning(1) quotation (1) ratio analsis (1)
ratio analysis (14) ratio anaysis (12) Reading
Strategies BBA 1 Semester (1) Receipt and Payment
Account: (1) Reinforcement Theory of Motivation (1)
Relationshipbetweenplanningandcontrolling(1) Rename
a file (1) Renaming (1) Reorder Level of Inventory (1)
Report Writing Format (1) Request letter (1) Research
design (1) Research Limitations .RM (1) Resume Writing
BBA 2 Semester (2) Retention Strategies Definition and
its Components (1) revenue curve (1) Revenue
expenditure(1) revision (1) RM (17) role and importance
of HRM BA 2 Semester (1) Role and Skills of Sales
Managers(1)RoleofaFinancialManagement (1) Role of
a Financial Manager (1) Role of a Leader (1) Role of a
Supervisor (1) Role of Communication Barriers in
Ineffective Communication (1) Role of Communication in
Group Discussion (1) Role of Consumer Behaviour in
Advertising (1) Role of Consumer Behaviour in Marketing
(1) Role of Effective Communication in Organization and
PersonalLife(1)RoleofFamilyinConsumerBehaviour (1)
Role of HR Manager in People Enabling and People
Empowerment (1) Role of HRD in Determining Fit
between an Employee and His Role (1) Role of HRD in
Facilitating Learning in the Organizations (1) Role of
Human Resource Management (HRM) in Leadership
Development (1) Roles and Responsibilities of a Portfolio
Manager (1) Sales letter BBA 2 Semester (1) Sales
Objectives (1) Sales Strategies.ADVERTISING AND
SALES MANAGEMENT (1) Sampling and non sampling
errors (1) SAMPLING PROCESS (1) Satellite
Communication System (1) saving and editing in ms
access BBA 2 Semester (1) Say's Law of Markets (1)
Schramms Model of Communication (1) scope (1) Scope
in management research (1) scope of cost accounting (1)
Scope of Financial Management (1) Scope of Human
Resource Management (1) SEBI (1) secondary data
collection (1) Security Analysis and Portfolio Management
(1)SelectingtherightPortfolioManager(1) Self Motivation
at Work (1) Selling Cost in Monopolistic Competition (1)
Seminar BBA 2 Semester (1) Set off of losses (1) Seven
CsofEffectiveCommunicationmanagement(1) Shannon
and Weaver Model of Communication (1) Shares and
StockMarketAnOverview(1) Simons model of decision
making(1) Situational Leadership Meaning and Concept
(1)SkillsRequiredforEffectiveManagerialCommunication
(1) Slide Animation (1) Slide Shows (1) Social (1) Social
Factors affecting Consumer Behaviour (1) software
developmentmodelsMIS(1)Sorting&Filtering(1)Sources
of Working Capital Financing (1) Speaking skill BBA 2
SEMESTER (1) Stabilization policies (1) Staffing Function
of Management (1) Staffing Process (1) Staffing Role of
theHRManager:StrategicWorkforcePlanning (1) Stages
in r Decision Process (1) Standard costing (1) standard
error of estimate (1) Standards and Checklist (1) Startup
Sequence (1) Static Dynamic Multiplier (1) Statistical
processcontrol(SPC)(1)statistics(16) Stock Valuation
The Discounted Cash Flow Approach in Detail (1)
Storage Media (1) Strategic Human Resource
Management (1) Strategies for Developing Listening Skills
BBA1Semester(1)Strategies to Improve Communication
(1) STRUCTURE OF DBMS (1) structured & unstructured
decisions (1) supply chain management (2) System
Analysis SRS (1) System Design (1) System
developmentlifecycle(1)SystemImplementation&testing
(1) tables (1) Taguchi philosophy (1) Talent Management
bySuccessfulCompanies:InsightsfromRecentResearch
(1) TAX MULTIPLIER: (1) Team Motivation Tips for
Motivating team (1) Techniques of Material Control (1)
TechniquesofScientificManagement(1)TechniquesUsed
inRatioAnalysis(1) Telnet (1) Termination Of An Offer (1)
The 10 Principles of Listening BBA 1 Semester (1) The 4
PsofPresentationEffectivenessBBA2Semester (1) The
BasicEconomicProblem:ScarcityandChoice(1)TheBoot
Procedure BBA 2 Semester (1) The Challenges of
ManagingAttritioninContemporaryOrganizations (1) THE
CIRCULAR FLOW OF INCOME (1) The Classical Theory
oftheRateofInterest(1)The HRM Function and its Role
inOrganizationalProcesses(1)The HRM Function and Its
Role in Recessionary Times (1) The Importance Of
Listening BBA 1 Semester (1) The Keynesian Theory (1)

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BBAStudyNotes:Utility:Cardinalutilityapproach,diminishingmarginalutility,lawofequimarginalutility,ordinalutilityapproach
The Listening Process (1) The Loanable Funds and other
theories (1) The Personal Selling Process ADVERTISING
AND SALES MANAGEMENT (1) The Process of
CorporateDecisionMaking(1)TheProductionFunction (1)
Theroleofmoney(1)TheRoleoftheFinanceFunction (1)
The Roles of the People Manager and the Project
Manager in Contemporary Organizations (1) Theorems of
probability (1) Theories of Distribution (1) Theories of
Interest Rate (1) Theory of Consumption Function (1)
TheoryofHumanResourceDevelopment(HRD)(1)theory
X and Theory Y (1) time series (1) Tips for a Successful
Group Discussion (1) Tips for Effective Managerial
Communication (1) Tips for Interviewee & Interviewer (1)
Tips for Professionals to Improve Communication (1) Tips
for Pursuing a Career in Human Resource Management
(1) Tips for Students and MBA Aspirants to Improve
Communication (1) Total Quality Management (1) Trading
and Profit and Loss Account (1) Training Methods and
Techniques(1)TrainingNeedsAssessmentAnImportant
HRD Function (1) Training of Employees Need and
Importance of Training (1) TRIAL BALANCE (1) Two
Fundamental Rules of Corporate Finance (1) types (1)
Types and Functions (1) types of information (1) Types of
investment (1) Types of Managerial Communication (1)
Types of Recruitment (1) Types of Research (1) Types of
Sampling (1) Types of Software (1) Typical Functions of a
Human Resource Manager (1)
Understanding
Communication and the Communication Process (1)
Understanding People's Needs (1) Understanding the
harmonyintheNature(1)use of databases for integration
across functional areas (1) Using accessories such as
calculator (1) Utility (1) Valuing Cash Flows in Different
Periods (1) Variable Pay and Performance Linked
Incentives (1) Variations and Interpretation (1) Various
applicationsofInternetsuchasSearchEngines(1) Various
Marketing Concepts BBA 2 Semester (1) Visual Aids in
Business Documents BBA 1 Semester (1) wants and
demandBBA2Semester(1)Ways to Improve Managerial
Communication at Workplace (1) Westley and MacLeans
Model of Communication (2) What are Bonds ? (1) What
aretheMethodsofPricingMaterialIssue(1)What Are the
StockandFlowVariables(1) What is a Financial Market ?
(1) What is Accounting ? (1) What is Annuity ? Meaning
and Concept (1) What is Bond Valuation and How is it
Calculated ? (1) What is Business Communication (1)
WhatisCapitalBudgeting(1)WhatisCorporateFinance?
(1) What is Cost of Equity ? Meaning and Concept (1)
What is Decision Making (1) What is Human Resource
Development (HRD) ? (1) What is Management (1) What
is Market Segmentation BBA 2 Semester (1) What is
Motivation (1) What is Perpetuity ? Definition and
Concept(1)WhatisRatioAnalysis? (1) What is Report ?
Meaning (1) What is Single Entry System ? Pros and
Cons (1) Who Uses Accounting Data ? (1) Work
Simplification(1)WorkStudy:Methodstudyandtimestudy
(1) Working Capital (1) Workplace Health and Safety (1)
Workplace Motivation Carrot or Stick approach doesnt
work anymore (1) Workplace Safety Programs (1) Writing
Paragraphs(1)WritingreportsBBA2Semester (1) Written
CommunicationMeaning(2)

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