Economics (NCERT) Notes

2.3 Ordinal Utility Analysis and Indifference Curve

Ordinal Utility Analysis
•Cardinal utility analysis suffers from a major drawback in the form of quantification of utility in numbers.
•In real life, we never express utility in the form of numbers.
•At the most, we can rank various alternative combinations in terms of having more or less utility.
•A consumer does not measure utility in numbers, though she often ranks various consumption bundles.
•This forms the starting point of this topic – Ordinal Utility Analysis.
 
Indifference curve
 

 

•The bundles available to the consumer can be plotted as points in a two-dimensional diagram.
•The points representing bundles which give the consumer equal utility can generally be joined to obtain a curve like the one in Figure.
•The consumer is said to be indifferent on the different bundles because each point of the bundles give the consumer equal utility.
•Such a curve joining all points representing bundles among which the consumer is indifferent is called an indifference curve.
 
Marginal rate of substitution (MRS)
•When a consumer gets one more banana, he has to forego some mangoes, so that her total utility level remains the same and she remains on the same indifference curve.
•Therefore, indifference curve slopes downward.
•The amount of mangoes that the consumer has to forego, in order to get an additional banana, her total utility level being the same, is called marginal rate of substitution (MRS).
•MRS is simply the rate at which the consumer will substitute Good A for Good B, so that her total utility remains constant.
MRS =|∆Y/∆X|
 
Marginal rate of substitution (MRS)
•When a consumer gets one more banana, he has to forego some mangoes, so that her total utility level remains the same and she remains on the same indifference curve.
•Therefore, indifference curve slopes downward.
•The amount of mangoes that the consumer has to forego, in order to get an additional banana, her total utility level being the same, is called marginal rate of substitution (MRS).
•MRS is simply the rate at which the consumer will substitute Good A for Good B, so that her total utility remains constant.
MRS =|∆Y/∆X|
 
Representation of Law of Diminishing Marginal Rate of Substitution
 

•As we increase the quantity of bananas, the quantity of mangoes sacrificed for each additional banana declines
•MRS thus diminishes with increase in the number of bananas
 
Law of Diminishing Marginal Rate of Substitution
•As the number of bananas with the consumer increases, the MU derived from each additional banana falls.
•With the fall in quantity of mangoes, the marginal utility derived from mangoes increases.
•So, with increase in the number of bananas, the consumer will feel the inclination to sacrifice small and smaller amounts of mangoes.
•This tendency for the MRS to fall with increase in quantity of bananas is known as Law of Diminishing Marginal Rate of Substitution.
 
Explanation 
•In the figure,
     •from point A to point B, the consumer sacrifices 3 mangoes for 1 banana,
     •from point B to point C, the consumer sacrifices 2 mangoes for 1 banana,
     •from point C to point D, the consumer sacrifices just 1 mango for 1 banana.
•Thus, the consumer sacrifices smaller and smaller quantities of mangoes for each additional banana.
 
Shape of an Indifference Curve
•The law of Diminishing Marginal Rate of Substitution causes an indifference curve to be convex to the origin, which is the most common shape of an indifference curve.
•However, in case of goods being perfect substitutes, the marginal rate of substitution does not diminish. It remains the same.   
 
Representation of Law of Diminishing Marginal Rate of Substitution
 

The consumer is indifferent for all these combinations as long as the total of five rupee coins and five rupee notes remains the same.
It hardly matters whether she gets a five rupee coin or a five rupee note.
Hence, the indifference curve depicting these will be a straight line.
 
Indifference Curve for perfect substitutes.

 




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