Page 49 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes
Example: You may prefer to consume or buy more apples than bananas while your
friend may prefer to consume or buy more bananas than apple.
The modern economists have discarded the concept of cardinal utility and have instead employed
the concept of ordinal utility for analysing consumer behaviour. The concept of ordinal utility
is based on the fact that it may not be possible for consumers to express the utility of a commodity
in absolute terms but it is always possible for a consumer to tell introspectively whether a
commodity is more or less or equally useful as compared to another.

Example: A consumer may not be able to tell that an ice cream gives 5 utils and a
chocolate gives 2 utils. But he or she can always tell whether chocolate gives more or less utility
than ice cream.
This assumption forms the basis of the ordinal theory of consumer behaviour. Ordinal utility is
the underlying assumption used in the analysis of indifference curves.

4.1.1 Marginal Utility Analysis

Marginal utility is an additional utility obtained from the consumption or use of an additional
unit of a good. It can be put in other words as the change in total utility divided by the change in
quantity. Marginal utility indicates an extra satisfaction from consuming an extra unit. Marginal
utility needs to be contrasted with the related term total utility. Marginal utility is the additional
amount of satisfaction obtained from consuming one additional unit of a good. Total utility is
the overall amount of satisfaction obtained from consuming several units of a good. While the
maximization of total utility represents the ultimate goal of consumption, the analysis of
consumer behaviour gives greater emphasis on the marginal utility.
As consumer proceeds with his consumption total utility increases as more of a good is consumed,
but the marginal utility decreases with the consumption of each additional unit. The decrease in
marginal utility with an increase in the consumption of a good reflects law of diminishing
marginal utility.

4.1.2 The Law of Diminishing Marginal Utility: Marshillian Approach

Marginal utility refers to the change in satisfaction which results when a little more or little less
of that good is consumed.

The law of diminishing marginal utility says that with the increase in the consumption of a
good there is a decrease in the marginal utility that person derives from consuming each additional
unit of that product.

Assumptions

The basic propositions of this traditional approach are

1. Cardinal measure of utility: Utility is a measurable and quantifiable concept. A person
can specify that he gets five units of utility by consuming one unit of good A etc. Utility is
an imaginary unit of measuring utility.
2. Independent utilities: Utility is additive; the utilities derived from different independent
goods can be added to get the measure of total utility.

3. Constant marginal utility of money: The marginal utility of money remains constant for a
particular consumer when he spends money on various goods. All other commodities except
money are subject to the law of diminishing marginal utility.

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