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# ORDINAL UTILITY APPROACH PPT NEW.pptx

ORDINAL UTILITY APPROACH MBA MANAGERIAL ECONOMICS I SEM

ORDINAL UTILITY APPROACH MBA MANAGERIAL ECONOMICS I SEM

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### ORDINAL UTILITY APPROACH PPT NEW.pptx

1. 1. ORDINAL UTILITY APPROACH BY:- ROHIT BHANDARI MBA 1 SEM
2. 2. INTRODUCTION ● Utility analysis is based on the assumption that cardinal measurement of utility is possible. But it is not a practical proposition. ● The consumer can at best compare the satisfaction derived from different goods or from different units of the same good. this is called an ordinal measurement of utility. ● Ordinal means ranked or ordered like first, second, or third.
3. 3. ORDINAL UTILITY APPROACH ORDINAL UTILITY APPROACH The basic idea behind the ordinal utility approach is that a consumer keeps a number of pairs of two commodities in his mind which gives him an equal level of satisfaction. This means that utility can be ranked qualitatively. The ordinal utility approach differs from the cardinal utility approach(also called classic theory) in the sense that the satisfaction derived from various commodities cannot be measured objectively ordinal theory is also known as the neo-classical theory of consumer equilibrium, Hicksiamn theory of consumer behaviour, indifference curve theory, optimal choice theory. This approach also explains the consumer’s equilibrium who is confronted with multiple objectives and scarcity of money income. The important tools of ordinal utility are:- 1 . The concept of indifference curves 2. The slop of I.C . i.e. marginal rate of substitution 3. The budget line
4. 4. Indifference curve ●Indifference Curve is a locus of all such points which shows different combinations of two commodities which yield equal satisfaction to the consumer so that he is indifferent to the particular combination he consumes. Assumption ⮚ Rational behavior of the consumer ⮚ Utility is ordinal ⮚ Diminishing marginal rate of substitution ⮚ Consistency in choice ⮚ Transitivity in choice making ⮚ Goods consumed are substitutable
5. 5. Indifference Schedule Combinations Apples Mangoes A 15 1 B 11 2 C 8 3 D 6 4 E 5 5
6. 6. Indifference curve ic shows all possible combinations of apples and mangoes between which a person is indifferent. Point a shows a consumption bundle consisting of 15 apples and one mango. Moving from point a to point b, we are willing to give up 4 apples to get a second manager (total utility is the same at points a and b)
7. 7. INDIFFERENCE MAP A graph showing a whole set of indifference curves is called an indifference map. All points on the same curve give equal levels of satisfaction, but each point on the higher curve gives a higher level of satisfaction.
8. 8. Properties of indifference curve Convex to the origin Negative Slope Asymptotic to the axes Directly proportional level of satisfaction Never intersects each other
9. 9. Exceptional Shapes of Indifference Curve
10. 10. Marginal rate of substitution (MRS) ● The marginal rate of substitution of x for y (mrs) is defined as the amount of Y, the consumer is just willing to give up to get one more unit of x and maintain the same level of satisfication.
11. 11. DIMINISHING MARGINAL RATE OF SUBSTITUTION ● As the consumer increases the consumption of apples, then for getting every additional unit of apples, he will give up less and less of oranges, that is 8:1,4:1, 2:1,1:1 respectively this is the law of diminishing mrs
12. 12. LAW OF DIMINISHING MRS MRS IS MEASURED BY SLOPE OF IC
13. 13. BUDGET LINE OR PRICE LINE ● IT SHOWS ALL POSSIBLE COMBINATIONS OF 2 GOODS THAT THE CONSUMER CAN BUY IF HE SPENDS THE WHOLE OF HIS GIVEN SUM OF 0F MONEY ON HIS PURCHASES AT THE GIVEN PRICES. BUDGET LINE COMBI NATIO N Apples( @Rs.6 per unit Oranges @ Rs. 2 Per unit Total budget (Rs.)=6x A+2x0 A 0 12 24 B 1 9 24 C 2 6 24 D 3 3 24 E 4 0 24
14. 14. BUDGET LINE
15. 15. Consumer Equilibrium ● A consumer seeks a market basket that generates the maximum level of happiness. However, one’s money income and the prices of goods impose a limit on the level of satisfaction that one may attain. Thus, the income at the disposal of the consumer in conjunction with the prices of their commodities will determine the budgetary constraint or the price line.
16. 16. Consumer equilibrium is attained when, given his budget constraint, the consumer reaches the highest possible point on the indifference curve. The maximum satisfaction is yielded when the consumer reaches equilibrium at the point of tangency between an indifference curve and the price line At point E, the price line is tangent to the indifference curve. At the equilibrium point, the slope of the indifference curve = slope of the price line the slope of the indifference curve = MRS The slope of the price line = PX /PY Thus, at point E, MRS = PX/PY Thus, satisfaction is maximized when the marginal rate of substitution of X For Y is equal to the price of X to the price of Y.
17. 17. ASSUMPTION ● Consumer income is constant ● Consumers know the price of all things ● Consumer can spend his income in small quantities ● Consumer is rational ● Consumer is fully aware of the indifference map. ● Goods are divisible.
18. 18. Condition of indifference curve 1)Price lines should be tangent to indifference curve. or Slope of IC = Slope of Price line Or MRSxy=Px/Py 2) Indifference Curve must be convex to the origin.
19. 19. Price line should be tangant to IC When the consumer is in equilibrium, his highest attainable Indifference Curve is tangent to price line. From figure : At point ‘D’ slope of Indifference Curve and price line coincide. Therefore, first condition of the consumer’s equikibrium is satisfied.
20. 20. Indifference ciurve must be convex to origin It Means that MRS of Apples for Oranges should be diminishing. If at the point of equilibrium, the indifference curve is Concave and not convex to the origin, then it will not be a position Of permanent equilibrium. Therefore, a consumer will be in permanent equilibrium where both conditions are satisfied.
21. 21. COMPARISON BASIS OF DIFFERENCE LAW OF DIMINISHING Marginal UTILITY Law of Diminishing rate of substitution 1) Measurement In cardinal/ordinal numbers Unrealistic assumption that marginal utility can be measured in cardinal numbers Realistic assumption that utility can be measured in ordinal numbers 2)Independence of Commodities Utility of one commodity is Independent of the utility of other commodity Utility of one commodity is dependent of the utility of other commodity. 3)Marginal utility of money (Mum) Assumption is that Mum remains constant No such assumption
22. 22. Criticism of indifference curve ●Old wine in a new bottle ●Away from reality ●Consumer is not rational ●Two goods model unrealistic ●All commodities are not divisible