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Introduction to the Cardinal Utility Theory
Utility analysis is the core concept of the theory of consumer’s behavior. Renowned classical economists such as William Stanley Jevons, Karl Menger, Leon Walras and Gossen developed the cardinal utility theory. However, significant contributions made by neo-classical economists, particularly Alfred Marshall, led the theory being known as ‘Neo-Classicial Utility Theory’ or ‘Marshallian Utility Theory’.
What does ‘Utility’ Mean in Economics?
All economic activities aim at fulfilling unlimited human wants. Utility can be regarded as the potentiality of goods or services to satisfy a human want. Since utility refers to the inherent quality of a commodity or service, it does not come under the purview of precise quantitative measurement. A person can only realize how much utility he or she derives from a commodity. Therefore, utility has no physical or material existence and the concept is purely subjective or introspective.
Peculiarities of ‘Utility’
Utility and Satisfaction
Note that ‘utility’ and ‘satisfaction’ are not same. Utility refers to expected satisfaction and satisfaction stands for realized satisfaction. Utility emerges when you think of buying a commodity. On the other hand, you get satisfaction after you consume the commodity. Therefore, a consumer can derive utility from a commodity even without purchasing it. However, consumption alone yields satisfaction to the consumer.
Sometimes, utility may not be equal to satisfaction. This means that the satisfaction you derive from a commodity may not meet your expectation. Though there are conspicuous differences between utility and satisfaction, the entire theory of consumer’s behavior works based on the assumption that the two concepts imply similar meaning. In other words, the assumption reads that the expected satisfaction is equal to the realized satisfaction.
Utility is a Relative Phenomenon
Since the concept of utility is subjective, it differs from person to person depending upon the personal needs and external circumstances. For example, a person, who is hungry, certainly derives high utility from a delicious meal. On the other hand, the utility derived from the same meal may be different for others. Similarly, the utility derived from a modern painting may be insignificant for people who do not know how to interpret it. At the same time, the painting gives tremendous utility to all connoisseurs. Therefore, utility is a relative phenomenon.
Utility is Ethically Neutral
Finally, the term utility possesses no ethical concerns or legal significance. For instance, tobacco products are pernicious or injurious to health. However, tobacco products give great amount of utility to a smoker. Similarly, possessing weapons is illegal; however, it gives immense utility to terrorists. As long as an activity involves economics, utility derived from such an activity has no moral or ethical connotation.
Cardinal and Ordinal Utility
Cardinal and Ordinal Numbers
Before looking at the concept of cardinal and ordinal utility, it is pertinent to learn what are cardinal and ordinal numbers. The terms ‘cardinal’ and ‘ordinal’ are widely used in mathematics. Cardinal numbers are 1, 2, 3, 4, 5, and so on. On the other hand, ordinal numbers are 1st, 2nd, 3rd, 4th, etc. As you notice, ordinal numbers imply ‘ordering’ or ‘ranking’.
The technique of cardinal utility traditionally precedes the ordinal utility method. The cardinalists, usually identified as neo-classicists, enlighten the principle of consumer’s behavior on the assumption that utility can be measured. As per the idea of cardinal utility, you are able to measure and compare the utilities of two goods. The units of measurements are imaginary; they are simply known as ‘utils’. For instance, let us consider apples and oranges. An apple may give the utility of 30 utils to a person at the same time an orange may provide him or her with the utility of 15 utils.
Measurement of Utility
Utility is a prejudiced or introspective notion associated with the internal perceptions and feelings of the customer. Therefore, it is certainly not possible for you to gauge the utility of a product to a shopper directly. However an indirect measure of utility is present in the price that is paid by the consumer for the specific commodity. Higher the price compensated by the customer for a product, greater will be its utility. Price could, therefore, be a measure of the utility of a commodity.
If a shopper is willing to spend two dollars for an apple and one dollar for an orange, then the utility of the apple to the buyer is twice that of the orange. To put it differently, the utilities of two distinct goods to one particular customer could be measured by the prices that he or she would like to pay for them. Money is, hence, a measuring rod, which is often used by the economists to determine utilities of goods. However this method of measuring utilities, it needs to be kept in mind, is not an ideal and trustworthy. It bears certain limitations and the economist knows about them.
The ordinalists uphold that amounts of utility are naturally non-measurable technically, conceptually as well as practically. They consider that the basic principles of consumer’s behavior could be described without the notion of quantifiable utility. As per the idea of ordinal utility, the utilities resulting from the usage of goods can never be measured and is little compared. The ordinal principle allows us to claim simply that the customer prefers an apple to an orange; however, it fails to reveal by how much. It really does not allow us to compare the volumes of utilities acquired from the two goods.
Theories based on Cardinal Utility Approach
There are two important laws to explain consumer’s behavior based on the cardinal utility approach. They are the following:
- The Law of Diminishing Marginal Utility or Gossen's First Law
- The Law of Equi-Marginal Utility or Gossen’s Second Law
Assumptions of the Cardinal Utility Approach
The principle of cardinal utility is based on the following assumptions:
Utility is Measurable
The basic assumption of cardinal utility approach is that utilities of commodities are quantifiable. According to Alfred Marshall, money acts as a measuring rod to measure utilities of commodities. Utility is measured based on the amount of money that a customer is willing to pay for the particular commodity.
Marginal Utility of Money is Constant
Marginal utility of money is assumed to be constant. This means that money must measure the same amount of utility in all circumstances. In other words, the utility derived from each unit of money is constant.This is necessary because money is used to measure utility of a commodity.
Utilities are Independent
The utility derived from one commodity is independent from the utility derived from another commodity. In other words, a customer’s basket does not contain goods that are substitutes or complements.
Therefore, TU = U1(x1) + U2(x2) + … + Un(xn)
Where, TU is the total utility, U1(x1) is the utility derived from the first good alone (x1), and U2(x2) is the utility derived from the second good alone (x2) and Un(xn) is the utility derived from the ‘n’th good alone (xn).
Diminishing Marginal Utility
The marginal utility of a commodity diminishes as a person consumes more and more quantities of it.
MUx = f(Qx)
The equation states that marginal utility of a commodity X (MUx) is a function of the quantity of X (Qx). The greater the quantity, the lesser is its marginal utility.
The cardinal utility approach assumes that the consumer is rational. This means that the consumer tries to maximize his or her utility with given income.
© 2013 Sundaram Ponnusamy