MICROECONOMICS

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 ORDINAL UTILITY APPROACH

Ordinal utility representing the preferences of an individual

on an ordinal scale. Ordinal utility is only meaningful to ask
which option is better than the other. All of the theory of
consumer decision-making under conditions of certainty can
be, and typically is, expressed in terms of ordinal utility.

Ordinal theory is also known as neo-classical theory of

consumer equilibrium.This approach also explains the
consumer's equilibrium who is confronted with the multiplicity
of objectives and scarcity of money income.
ASSUMPTION OF ORDINAL UTILITY APPROACH

1. A consumer substitutes commodities rationally in order to

maximize his level of satisfaction.
2. A consumer can rank his preferences according to the
satisfaction of each basket of goods.
3. The consumer is consistent in his choices.
4. It is assumed that each of the good is divisible.
 5. It is assumed that the consumer has full knowledge of
prices in the market.
6. The consumer's scale of preferences is so complete
that consumer is indifferent between them.
7. Two commodities are used by the consumer. It is
also known as two commodities model.
8. Two commodities X and Y are substitutes of each
other. These commodities can be easily substituted in various
pairs.
The important tools of ordinal utility are:
1. The concept of indifference curves.
2. The slope of I.C. i.e. marginal rate of substitution.
3. The budget line.
 Indifference curve
An indifference curve is combination of two goods that give
the consumer equal satisfaction and utility. Each point on
an indifference curve indicates that a consumer at all given
points gives the same level of satisfaction.
The indifference curve is drawn as a downward sloping to the origin. The graph
shows a combination of two goods that the consumer consumes.

The graph shows the U indifference curve showing bundles of goods A and B. To
the consumer, A and B give him the equal satisfaction. In other words, point A gives
as much utility as point B to the individual. The consumer will be satisfied at any
point along the curve.
In the diagram, two indifference curves are showing each other at point B. The
combinations represented by points B and F given equal satisfaction to the
consumer because both lie on the same indifference curve IC2. Similarly the
combinations shows by points B and E on indifference curve IC1 give equal
satisfaction top the consumer.
If combination F is equal to combination B in terms of
satisfaction and combination E is equal to combination B in
satisfaction. It follows that the combination F will be
equivalent to E in terms of satisfaction. This combination F on
IC2 contains more of good Y than combination which gives
more satisfaction to the consumer. We, therefore, conclude
that indifference curves cannot cut each other.
 BUDGET LINE

This budget line shows all those combinations of two goods

which the consumer can buy spending his given money income
on the two goods at their given prices.
A person has Rs 50 for buying pens. He has the following options for allocating his
amount such that he derives the maximum utility from limited income:
The budget line shift upward after fall in the price of Good 2.

We can afford more Good 2 with the same

Same income.
 Fig 1 Fig 2

Fig 1: Increase in income causes increment in purchasing power for the consumer. This
cause parallel upward shift in the budget line.

Fig 2: Fall in income causes reduction in purchasing power for the consumer. This
cause parallel downward shift in the budget line.
 INFERIOR, SUPERIOR AND NORMAL GOODS
Inferior good is a good whose demand decreases when consumer
income rises (or demand increases when consumer income
decreases)

Example: When income is low, people prefer bus ridding. But as

income increases, people stop riding the bus and start buying cars.

.
Superior goods is also known as luxury goods that displace
the demand of inferior goods after rise in income. They are
kind of normal goods as their demand increases when
income increase

Example: Demand for the holidays in foreign countries.

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