Lesson 1: Cardinal Utility Approach

Video Lesson:

Competency (MLC)

Dear Learners,

By the end of this lesson, you will be able to:

• Define cardinal utility and its significance in consumer behavior.
• Explain the principles underlying the cardinal utility approach.
• Apply the concept of marginal utility to derive demand curves.
• Discuss the assumptions of the cardinal utility approach.
• Illustrate how utility functions can represent consumer preferences.

Brainstorming Questions:

• How does the concept of marginal utility influence consumer purchasing decisions?
• In what ways can the law of diminishing marginal utility be observed in everyday consumption?
• What challenges arise in quantifying utility in cardinal terms?
• How do changes in income and prices affect a consumer’s utility and choices?

Key Terms

1.1 Introduction

The cardinal utility approach is a key concept in consumer behavior theory, primarily developed by economists in the early 20th century. It posits that utility, or satisfaction, derived from consumption can be quantified in measurable terms. Unlike ordinal utility, which merely ranks preferences, cardinal utility assigns a specific numerical value to the satisfaction derived from goods and services.

1.2 Cardinal Utility

In economics, utility refers to the satisfaction or pleasure derived from consuming goods and services. Total utility refers to the overall satisfaction from consuming a certain quantity, while marginal utility focuses on the additional satisfaction from consuming one more unit. The cardinal utility approach asserts that this satisfaction can be expressed in absolute numbers (utils). This approach allows economists to analyses consumer behavior through measurable metrics, making it easier to derive demand curves and understand consumer choices.

Key Distinction:

While ordinal utility ranks preferences without quantifying them, cardinal utility provides a numerical representation of satisfaction, allowing for more precise analysis.

1.2.1 Assumptions of Cardinal Utility

Utility Measurement:

Cardinal utility assumes utility can be measured with cardinal numbers and measures total and marginal utility numerically.

Diminishing Marginal Utility:

One of the central tenets of cardinal utility is the law of diminishing marginal utility, which states that as consumers consume more units of a good, the additional satisfaction from each additional unit tends to decrease.

Utility Maximization:

Consumers aim to maximize their total utility given their budget constraints. They allocate their spending in a way that equalizes the marginal utility per dollar spent across all goods.

Consumer Choice:

The cardinal utility approach provides insights into how consumers make choices based on their preferences and the utility derived from various goods and services. The marginal utility ratios for any two goods equals the price ratios.

No Saving:

The consumer spends his/her entire income

Limited income a consumer:

The consumer faces limited money income i.e. scarcity of resources and hence, choice is mandatory.

Demand Curve Derivation:

The relationship between price and quantity demanded can be established through the concept of marginal utility. As the price of a good decreases, the quantity demanded increases, reflecting the law of demand.

Rational Behavior:

Consumers are assumed to be rational and well informed about the merit of their respective their decisions.

CONSUMER OPTIMUM

• Given any two consumption bundles, the consumer can compare and decide that one of consumption bundles is better than another, or that they lead to the same satisfaction.
• The consumer is expected to state his/her preference.

$$\frac{M{U}_x}{M{U}_y}=\frac{P_x}{P_y}\text{or}\frac{M{U}_x}{P_x}=\frac{M{U}_y}{P_y}\text{and income = expenditure}$$

1.3 Derivation of the Demand Curve

To illustrate the relationship between marginal utility and demand, consider a consumer deciding how many units of a good to purchase. If the price of a good is lower than the marginal utility derived from it, the consumer will purchase additional units. Conversely, if the price exceeds the marginal utility, the consumer will reduce their purchases.

Demand Curve:

The demand curve can be derived from the marginal utility schedule, showing how quantity demanded varies with price. As price decreases, quantity demanded increases, resulting in a downward-sloping demand curve.

• The demand curve is derived from the Consumer optimum.
• The   concept   of  diminishing    marginal utility.
• The demand curve for a commodity is the same as the positive segment of the marginal utility curve