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Unit 5: Consumer Behaviour: Cardinal Approach

3. The prices of all goods are given and known to a consumer. Notes

4. He is one of the many buyers in the sense that he is powerless to alter the market price.
5. He can spend his income in small amounts.
6. He acts rationally in the sense that he want maximum satisfaction.
7. Utility is measured cardinally. This means that utility, or use of a good, can be expressed in
terms of “units” or “utils”. This utility is not only comparable but also quantifi able.
Principle

Suppose there are two goods ‘x’ and ‘y’ on which the consumer has to spend his given income.
The consumer’s behavior is based on two factors:
1. Marginal Utilities of goods ‘x’ and ‘y’
2. The prices of goods ‘x’ and ‘y’

The consumer is in equilibrium position when marginal utility of money expenditure on each
good is the same.
Mathematically, the law can be explained by the help of the following formula:

MU of good A/Price of A = MU of good B/Price of B
In any case when the Marginal Utilities of the goods A and B are unequal, the consumer will
purchase a combination that will give him highest Marginal Utility per dollar value of each good,
in such a way that the entire budget amount is spent.

Task Do you think that there are exceptions to the law of diminishing marginal
utility? Validate your opinion with the help of examples.

5.4 Consumer Equilibrium using Cardinal Approach

Law of Equi-marginal Utility or the principle of Equi-marginal utility says that the consumer
would maximise his utility if he allocates his expenditure on various goods he consumes such
that the utility of the last rupee spent on each good is equal.
Suppose your utility function is U = u (X). You buy good X. Your total expenditure is X. P .
x
(where P is the price of X)
x
Presumably, you would want to maximise the difference between your utility and expenditure
L = u (X) – X. P
x

By way of first order condition [condition for the value of a variable to be stationary (not moving)
at zero.]
dL = ⎡ du − P ⎤ = 0
dx ⎢ ⎣ dx x ⎥ ⎦
Where, dL/dx = d (U (X)- X.P )/dX
x
du
And the term stands for marginal utility of X (MU )
dx x

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