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Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Derivation of the Consumer’s Demand Curve: Normal Goods

We have already seen how the price consumption curve traces the effect of a change in price of a good on its quantity demanded. However, it does not directly show the relationship between the price of a good and its corresponding quantity demanded. It is the demand curve that shows relationship between price of a good and its quantity demanded. In this section we are going to derive the consumer’s demand curve from the price consumption curve . Figure.1 shows derivation of the consumer’s demand curve from the price consumption curve where good X is a normal good.

FIGURE.1 Derivation of the Demand Curve: Normal GoodsDemand11.jpegThe upper panel of Figure.1 shows price effect where good X is a normal good. AB is the initial price line. Suppose the initial price of good X (Px) is OP. e is the initial optimal consumption combination on indifference curve U. The consumer buys OX units of good X. When price of X (Px)falls, to say OP1, the budget constraint shift to AB1. The optimal consumption combination is e1on indifference curve U1. The consumer now increases consumption of good X from OX to OX1 units. The Price Consumption Curve (PCC) is rising upwards.

Chart.1 shows the demand relationship derived form the price consumption curve.

Chart.1Tablea1.JPG
The lower panel of Figure.1 shows this price and corresponding quantity demanded of good X as shown in Chart.1. At initial price OP, quantity demanded of good X is OX. This is shown by point a. At a lower price OP1, quantity demanded increases to OX1. This is shown by point b. DD1 is the demand curve obtained by joining points a and b. The demand curve is downward sloping showing inverse relationship between price and quantity demanded as good X is a normal good.

Derivation of the Consumer’s Demand Curve: Giffen Goods

In this section we are going to derive the consumer’s demand curve from the price consumption curve in the case of inferior goods. Figure.2 shows derivation of the consumer’s demand curve from the price consumption curve where good X is an inferior good.

FIGURE.2 Derivation of the Demand Curve: Inferior GoodsDemand2b.jpeg
The upper panel of Figure.2 shows price effect where good X is an inferior good. AB is the initial price line. Suppose the initial price of good X (Px)is OP. e is the initial optimal consumption combination on indifference curve U. The consumer buys OX units of good X. When price of X Px) falls, to say OP1, the budget constraint shift to AB1. The optimal consumption combination is e1on indifference curve U1. The consumer now reduces consumption of good X from OX to OX1 units as good x is inferior. The Price Consumption Curve (PCC) is rising upwards and bending backwards towards the Y-axis.

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University:
Chart.1 shows the demand relationship derived form the price consumption curve.

Chart.2Tablea1.JPG
The lower panel of Figure.2 shows this price and corresponding quantity demanded of good X as shown in Chart.2. At initial price OP, quantity demanded of good X is OX. This is shown by point a. At a lower price OP1, quantity demanded decreases to OX1. This is shown by point b. DD1 is the demand curve obtained by joining points a and b. The demand curve is upward sloping showing direct relationship between price and quantity demanded as good X is an inferior good.

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Key Differences Between Cardinal and Ordinal Utility

The following points are noteworthy so far as the difference between cardinal and ordinal utility is concerned:

  1. Cardinal utility is the utility wherein the satisfaction derived by the consumers from the consumption of good or service can be measured numerically. Ordinal utility states that the satisfaction which a consumer derives from the consumption of product or service cannot be measured numerically.
  2. Cardinal utility measures the utility objectively, whereas there is a subjective measurement of ordinal utility.
  3. Cardinal utility is less realistic, as quantitative measurement of utility is not possible. On the other end, the ordinal utility is more realistic as it relies on qualitative measurement.
  4. Cardinal utility, is based on marginal utility analysis. As against this, the concept of ordinal utility is based on indifference curve analysis.
  5. The cardinal utility is measured in terms of utils, i.e. units of utility. On the contrary, the ordinal utility is measured in terms of ranking of preferences of a commodity when compared to each other.
  6. Cardinal utility approach propounded by Alfred Marshall and his followers. Conversely, ordinal utility approach pioneered by Hicks and Allen.

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Definition of Cardinal Utility

The notion of Cardinal utility was formulated by Neo-classical economists, who hold that utility is measurable and can be expressed quantitatively or cardinally, i.e. 1, 2, 3, and so on. The traditional economists developed the theory of consumption based on cardinal measurement of utility, for which they coined the term ‘Util‘ expands to Units of utility. It is assumed that one util is equal to one unit of money, and there is the constant utility of money.

Further, it has been realised with the passage of time that the cardinal measurement of utility is not possible, thus less realistic. There are many difficulties in measuring utility numerically, as the utility derived by the consumer from a good or service depends on a number of factors such as mood, interest, taste, preferences and much more.

Definition of Ordinal Utility

Ordinal Utility is propounded by the modern economists, J.R. Hicks, and R.G.D. Allen, which states that it is not possible for consumers to express the satisfaction derived from a commodity in absolute or numerical terms. Modern Economists hold that utility being a psychological phenomenon, cannot be measured quantitatively, theoretically and conceptually. However, a person can introspectively express whether a good or service provides more, less or equal satisfaction when compared to one another.

In this way, the measurement of utility is ordinal, i.e. qualitative, based on the ranking of preferences for commodities. For example: Suppose a person prefers tea to coffee and coffee to milk. Hence, he or she can tell subjectively, his/her preferences, i.e. tea > coffee > milk.

Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

Recommended Mcom Notes

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Cardinal and ordinal approaches to the derivation of the demand function for Managerial Economics Mcom Delhi University

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