THE THEORY OF CONSUMER BEHAVIOR: CARDINAL Vs ORDINAL UTILITY

ANALYSIS

Introduction

The theory of consumer behavior built on both the cardinal and ordinal approach is attributed to
modern economists such as Alfred Marshal, J. R. Hicks and R. G. Allen. The cardinal utility
analysis believes that utility can be measured quantitatively in monetary units (utils) which
attracted criticisms and led to the development of the ordinal utility analysis. The ordinals
maintained that utility is not measurable.
The Cardinal Utility Theory
Cardinal utility analysis is the oldest theory of demand which provides an explanation of
consumer’s demand for a product and derives the law of demand which establishes an inverse
relationship between price and quantity demanded of a product.
Introduction:
The price of a product depends upon the demand for and the supply of it. In this part of the book
we are concerned with the theory of consumer’s behaviour, which explains his demand for a
good and the factors determining it. Individual’s demand for a product depends upon price of the
product, income of the individual, the prices of related goods.
It can be put in the following functional form:
Dx= f(Px, I, Py, Pz, T etc.)
where Dx stands for the demand of good X, Px for price of good X, I for individual’s income, Py
Pz for the prices of related goods and T for tastes and preferences of the individual. But among
these determinants of demand, economists single out price of the good in question as the most
important factor governing the demand for it. Indeed, the function of a theory of consumer’s
behaviour is to establish a relationship between quantity demanded of a good and its own price
and to provide an explanation for it.
Recently, cardinal utility approach to the theory of demand has been subjected to severe
criticisms and as a result some alternative theories, namely, Indifference Curve Analysis,
Samuelson’s Revealed Preference Theory, and Hicks’ Logical Weak Ordering Theory have been
propounded.
Assumptions of Cardinal Utility Analysis:
Cardinal utility analysis of demand is based upon certain important assumptions. Before
explaining how cardinal utility analysis explains consumer’s equilibrium in regard to the demand
for a good, it is essential to describe the basic assumptions on which the whole utility analysis
rests. As we shall see later, cardinal utility analysis has been criticised because of its unrealistic
assumptions.
The basic assumptions or premises of cardinal utility analysis are as follows:
The Cardinal Measurability of Utility:
The exponents of cardinal utility analysis regard utility to be a cardinal concept. In other words,
they hold that utility is a measurable and quantifiable entity. According to them, a person can
express utility or satisfaction he derives from the goods in the quantitative cardinal terms. Thus,
a person can say that he derives utility equal to 10 units from the consumption of a unit of good
A, and 20 units from the consumption of a unit of good B.
Moreover, the cardinal measurement of utility implies that a person can compare utilities derived
from goods in respect of size, that is, how much one level of utility is greater than another. A
person can say that the utility he gets from the consumption of one unit of good B is double the
utility he obtains from the consumption of one unit of good A.
According to Marshall, marginal utility is actually measurable in terms of money. Money
represents the general purchasing power and it can therefore be regarded as a command over
alternative utility-yielding goods. Marshall argues that the amount of money which a person is
prepared to pay for a unit of a good rather than go without it is a measure of the utility he derives
from that good.
Thus, according to him, money is the measuring rod of utility Some economists belonging to the
cardinalist school measure utility in imaginary units called “utils” They assume that a consumer
is capable of saying that one apple provides him utility equal to 4 utils. Further, on this ground,
he can say that he gets twice as much utility from an apple as compared to an orange.
The Hypothesis of Independent Utilities:
The second important tenet of the cardinal utility analysis is the hypothesis of independent
utilities. On this hypothesis, the utility which a consumer derives from a good is the function of
the quantity of that good and of that good only In other words, the utility which a consumer
obtains from a good does not depend upon the quantity consumed of other goods; it depends
upon the quantity purchased of that good alone.
On this assumption, then the total utility which a person gets from the whole collection of goods
purchased by him is simply the total sum of the separate utilities of the goods. Thus, the
cardinalist school regards utility as ‘additive’, that is, separate utilities of different goods can be
added to obtain the total sum of the utilities of all goods purchased.
Constancy of the Marginal Utility of Money:
Another important assumption of the cardinal utility analysis is the constancy of the marginal
utility of money. Thus, while the cardinal utility analysis assumes that marginal utilities of
commodities diminish as more of them are purchased or consumed, but the marginal utility of
money remains constant throughout when the individual is spending money on a good and due to
which the amount of money with him varies. Daniel Bernoulli first of all introduced this
assumption but later Marshall adopted this in his famous book “Principles of Economics’.
As stated above, Marshall measured marginal utilities in terms of money. But measurement of
marginal utility of goods in terms of money is only possible if the marginal utility of money
itself remains constant. It should be noted that the assumption of constant marginal utility of
money is very crucial to the Marshallian analysis, because otherwise Marshall could not measure
the marginal utilities of goods in terms of money. If money which is the unit of measurement
itself varies as one is measuring with it, it cannot then yield correct measurement of the marginal
utility of goods.
When price of a good falls and as a result the real income of the consumer rises, marginal utility
of money to him will fall but Marshall ignored this and assumed that marginal utility of money
did not change as a result of the change in price. Likewise, when price of a good rises the real
income of the consumer will fall and his marginal utility of money will rise. But Marshall
ignored this and assumed that marginal utility of money remains the same. Marshall defended
this assumption on the ground that “his (the individual consumer’s) expenditure on any one thing
is only a small part of his whole expenditure.”
Introspective Method:
Another important assumption of the cardinal utility analysis is the use of introspective method
in judging the behaviour of marginal utility. “Introspection is the ability of the observer to
reconstruct events which go on in the mind of another person with the help of self-observation.
This form of comprehension may be just guesswork or intuition or the result of long lasting
experience.”
Thus, the economists construct with the help of their own experience the trend of feeling which
goes on in other men’s mind. From his own response to certain forces and by experience and
observation one gains understanding of the way other people’s minds would work in similar
situations. To sum up, in introspective method we attribute to another person what we know of
our own mind. That is, by looking into ourselves we see inside the heads of other individuals.
So the law of diminishing marginal utility is based upon introspection. We know from our own
mind that as we have more of a thing, the less utility we derive from an additional unit of it. We
conclude from it that other individuals’ mind will work in a similar fashion, that is, marginal
utility to them of a good will diminish as they have more units of it.
With the above basic premises, the founders of cardinal utility analysis have developed two laws
which occupy an important place in economic theory and have several applications and uses.
These two laws are:
(1) Law of Diminishing Marginal Utility and
(2) Law of Equi-Marginal Utility.
It is with the help of these two laws about consumer’s behaviour that the exponents of cardinal
utility analysis have derived the law of demand. We explain below these two laws in detail and
how law of demand is derived from them.
Law of Diminishing Marginal Utility:
An important tenet of cardinal utility analysis relates to the behaviour of marginal utility. This
familiar behaviour of marginal utility has been stated in the Law of Diminishing Marginal Utility
according to which marginal utility of a good diminishes as an individual consumes more units
of a good. In other words, as a consumer takes more units of a good, the extra utility or
satisfaction that he derives from an extra unit of the good goes on falling.
It should be carefully noted that it is the marginal utility and not the total utility that declines
with the increase in the consumption of a good. The law of diminishing marginal utility means
that the total utility increases at a decreasing rate.
Marshall who has been a famous exponent of the cardinal utility analysis has stated the law of
diminishing marginal utility as follows:
“The additional benefit which a person derives from a given increase of his stock of a thing
diminishes with every increase in the stock that he already has.”
This law is based upon two important facts. First, while the total wants of a man are virtually
unlimited, each single want is satiable. Therefore, as an individual consumes more and more
units of a good, intensity of his want for the good goes on falling and a point is reached where
the individual no longer wants any more units of the good. That is, when saturation point is
reached, marginal utility of a good becomes zero. Zero marginal utility of a good implies that the
individual has all that he wants of the good in question.
The second fact on which the law of diminishing marginal utility is based is that the different
goods are not perfect substitutes for each other in the satisfaction of various wants. When an
individual consumes more and more units of a good, the intensity of his particular want for the
good diminishes but if the units of that good could be devoted to the satisfaction of other wants
and yielded as much satisfaction as they did initially in the satisfaction of the first want, marginal
utility of the good would not have diminished.
It is obvious from above that the law of diminishing marginal utility describes a familiar and
fundamental tendency of human nature. This law has been arrived at by introspection and by
observing how consumers behave.
Illustration of the Law of Diminishing Marginal Utility:
Consider Table 7 1 where we have presented the total and marginal utilities derived by a person
from cups of tea consumed per day. When one cup of tea is taken per day the total utility derived
by the person is 12 utils. And because this is the first cup its marginal utility is also 12 utils with
the consumption of 2nd cup per day, the total utility rises to 22 utils but marginal utility falls to
10. It will be seen from the table that as the consumption of tea increases to six cups per day,
marginal utility from the additional cup goes on diminishing (i.e. the total utility goes on
increasing at a diminishing rate).
However, when the cups of tea consumed per day increases to seven, then instead of giving
positive marginal utility, the seventh cup gives negative marginal utility equal to – 2 utils. This is
because too many cups of tea consumed per day (say more than six for a particular individual)
may cause acidity and gas trouble. Thus, the extra cups of tea beyond six to the individual in
question gives him disutility rather than positive satisfaction.
Figure 7.1 illustrates the total utility and the marginal utility curves. The total utility curve drawn
in Figure 7.1 is based upon three assumptions. First, as the quantity consumed per period by a
consumer increases his total utility increases but at a decreasing rate. This implies that as the
consumption per period of a commodity by the consumer increases, marginal utility diminishes
as shown in the lower panel of Figure 7.1.
Secondly, as will be observed from the figure when the rate of consumption of a commodity per
period increases to Q4, the total utility of the consumer reaches its maximum level.
Therefore, the quantity Q4 of the commodity is called satiation quantity or satiety point. Thirdly,
the increase in the quantity consumed of the good per period by the consumer beyond the
satiation point has an adverse effect on his total utility that is, his total utility declines if more
than Q4 quantity of the good is consumed.
This means beyond Q4 marginal utility of the commodity for the consumer becomes negative
ads will be seen from the lower panel of Figure 7.1 beyond the satiation point Q4 marginal utility
curve MU goes below the X-axis indicating it becomes negative beyond quantity Q4 per period
of the commodity consumed.
It is important to understand how we have drawn the marginal utility curve. As stated above
marginal utility is the increase in total utility of the consumer caused by the consumption of an
additional unit of the commodity per period. We can directly find out the marginal utility of the
successive units of the commodity consumed by measuring the additional utility which a
consumer obtains from successive units of the commodity and plotting them against their
respective quantities.
However, in terms of calculus, marginal utility of a commodity X is the slope of the total utility
function U = f(Qx). Thus, we can derive the marginal utility curve by measuring the slope at
various points of the total utility curve TU in the upper panel of Figure7.1 by drawing tangents at
them. For instance, at the quantity Q1 marginal utility (i.e. dU/ dQ = MU1) is found out by
drawing tangent at point A and measuring its slope which is then plotted against quantity in the
lower panel of Figure 7.1. In the lower panel we measure marginal utility of the commodity on
the Y-axis. Likewise, at quantity Q2 marginal utility of the commodity has been obtained by
measuring slope of the total utility curve TU at point B and plotting it in the lower panel against
the quantity Q2.
It will be seen from the figure that at Q4 of the commodity consumed, the total utility reaches at
the maximum level T. Therefore, at quantity Q4 the slope of the total utility curve is zero at this
point. Beyond the quantity Q4 the total utility declines and marginal utility becomes negative.
Thus, quantity Q4 of the commodity represents the satiation quantity.

Another important relationship between total utility and marginal utility is worth noting. At any
quantity of a commodity consumed the total utility is the sum of the marginal utilities. For
example, if marginal utility of the first, second, and third units of the commodity consumed are
15, 12, and 8 units, the total utility obtained from these three units of consumption of the
commodity must equals 35 units (15 + 12 + 8 = 35).
Similarly, in terms of graphs of total utility and marginal utility depicted in Figure 7.1 the total
utility of the quantity Q4 of the commodity consumed is the sum of the marginal utilities of the
units of commodity up to point Q4. That is, the entire area under the marginal utility curve MU
in lower panel up to the point Q4 is the sum of marginal utilities which must be equal to the total
utility Q4T in the upper panel.
Marginal Utility and Consumer’s Tastes and Preferences:
The utility people derive from consuming a particular commodity depends on their tastes and
preferences. Some consumers like oranges, others prefer apples and still others prefer bananas
for consumption. Therefore, the utility which different individuals get from these various fruits
depends on their tastes and preferences.
An individual would have different marginal utility curves for different commodities depending
on his tastes and preferences. Thus, utility which people derive from various goods reflect their
tastes and preferences for them. However, it is worth noting that we cannot compare utility
across consumers. Each consumer has a unique subjective utility scale. In the context of cardinal
utility analysis, a change in consumer’s tastes and preferences means a shift in his one or more
marginal utility curves.
However, it may be noted that a consumer’s tastes and preferences do not frequently change, as
these are determined by his habits. Of course, tastes and preferences can change occasionally.
Therefore, in economic theory we generally assume that tastes or preferences are given and
relatively stable.
Significance of Diminishing Marginal Utility:
The significance of the diminishing marginal utility of a good for the theory of demand is that it
helps us to show that the quantity demanded of a good increase as its price falls and vice versa.
Thus, it is because of the diminishing marginal utility that the demand curve slopes downward. If
properly understood the law of diminishing marginal utility applies to all objects of desire
including money.
But it is worth mentioning that marginal utility of money is generally never zero or negative.
Money represents purchasing power over all other goods, that is, a man can satisfy all his
material wants if he possesses enough money. Since man’s total wants are practically unlimited,
therefore, the marginal utility of money to him never falls to zero.
The marginal utility analysis has a good number of uses and applications in both economic
theory and policy. The concept of marginal utility is of crucial significance in explaining
determination of the prices of commodities. The discovery of the concept of marginal utility has
helped us to explain the paradox of value which troubled Adam Smith in “The Wealth of
Nations.”
Adam Smith was greatly surprised to know why water which is so very essential and useful to
life has such a low price (indeed no price), while diamonds which are quite unnecessary, have
such a high price. He could not resolve this water-diamond paradox. But modern economists can
solve it with the aid of the concept of marginal utility.
According to the modern economists, the total utility of a commodity does not determine the
price of a commodity and it is the marginal utility which is crucially important determinant of
price. Now, the water is available in abundant quantities so that its relative marginal utility is
very low or even zero. Therefore, its price is low or zero. On the other hand, the diamonds are
scarce and therefore their relative marginal utility is quite high and this is the reason why their
prices are high.
Prof. Samuelson explains this paradox of value in the following words:
The more there is of a commodity, the less the relative desirability of its last little unit becomes,
even though its total usefulness grows as we get more of the commodity. So, it is obvious why a
large amount of water has a low price or why air is actually a free good despite its vast
usefulness. The many later units pull down the market value of all units.
Besides, the Marshallian concept of consumer’s surplus is based on the principle of diminishing
marginal utility.
Consumer’s Equilibrium: Principle of Equi-Marginal Utility:
Principle of equi-marginal utility occupies an important place in cardinal utility analysis. It is
through this principle that consumer’s equilibrium is explained. A consumer has a given income
which he has to spend on various goods he wants. Now, the question is how he would allocate
his given money income among various goods, that is to say, what would be his equilibrium
position in respect of the purchases of the various goods. It may be mentioned here that
consumer is assumed to be ‘rational’, that is, he carefully calculates utilities and substitutes one
good for another so as to maximise his utility or satisfaction.
Suppose there are only two goods X and Y on which a consumer has to spend a given income.
The consumer’s behaviour will be governed by two factors first, the marginal utilities of the
goods and secondly, the prices of two goods. Suppose the prices of the goods are given for the
consumer.
The law of equi-marginal utility states that the consumer will distribute his money income
between the goods in such a way that the utility derived from the last rupee spent on each good is
equal. In other words, consumer is in equilibrium position when marginal utility of money
expenditure on each good is the same. Now, the marginal utility of money expenditure on a good
is equal to the marginal utility of a good divided by the price of the good. In symbols,
MUm = MUx / Px
Where MUm is marginal utility of money expenditure and MUm is the marginal utility of X and
Px is the price of X. The law of equi-marginal utility can therefore be stated thus: the consumer
will spend his money income on different goods in such a way that marginal utility of money
expenditure on each good is equal. That is, consumer is in equilibrium in respect of the purchases
of two goods X and V when
MUx / Px= MUy / Py
Now, if MUx / Px and MUy / Py are not equal and MUx / Px is greater than MUy / Py, then the
consumer will substitute good X for good Y. As a result of this substitution, the marginal utility
of good X will fall and marginal utility of good y will rise. The consumer will continue
substituting good X for good Y until MUx / Px becomes equal to MUy / Py. When MUx / Px
becomes equal to MUy / Py the consumer will be in equilibrium.
But the equality of MUx / Px with MUy / Py can be achieved not only at one level but at
different levels of expenditure. The question is how far does a consumer go in purchasing the
goods he wants. This is determined by the size of his money income. With a given income and
money expenditure a rupee has a certain utility for him: this utility is the marginal utility of
money to him.
Since the law of diminishing marginal utility applies to money income also, the greater the size
of his money income the smaller the marginal utility of money to him. Now, the consumer will
go on purchasing goods until the marginal utility of money expenditure on each good becomes
equal to the marginal utility of money to him.
Thus, the consumer will be in equilibrium when the following equation holds good:
MUx / Px = MUy / Py = MUm
Where MUm is marginal utility of money expenditure (that is, the utility of the last rupee spent
on each good).
If there are more than two goods on which the consumer is spending his income, the above
equation must hold good for all of them. Thus
MUx / Px = MUy / Py = …….. = MUm
Let us illustrate the law of equi-marginal utility with the aid of an arithmetical table given below:

Let the prices of goods X and Y be Rs. 2 and Rs. 3 respectively. Reconstructing the above table
by dividing marginal utilities (MU) of X by Rs. 2 and marginal utilities (MU) of 7 by Rs. 3 we
get the Table 7.3.

Suppose a consumer has money income of Rs. 24 to spend on the two goods. It is worth noting
that in order to maximise his utility the consumer will not equate marginal utilities of the goods
because prices of the two goods are different. He will equate the marginal utility of the last rupee
(i.e. marginal utility of money expenditure) spent on these two goods.
In other words, he will equate MUx / Px with MUy / Py while spending his given money income
on the two goods. By looking at the Table 7.3 it will become clear that MUx / Px is equal to 5
utils when the consumer purchases 6 units of good X and MUy / Py is equal to 5 utils when he
buys 4 units of good Y. Therefore, consumer will be in equilibrium when he is buying 6 units of
good X and 4 units of good 7and will be spending (Rs. 2 x 6 + Rs. 3 x 4 ) = Rs. 24 on them that
are equal to consumer’s given income. Thus, in the equilibrium position where the consumer
maximises his utility.
MUx / Px = MUy / Py = MUm
10/2 = 15/3 =5
Thus, marginal utility of the last rupee spent on each of the two goods he purchases is the same,
that is, 5 utils.
Consumers’ equilibrium is graphically portrayed in Fig. 7.2. Since marginal utility curves of
goods slope downward, curves depicting and MUx / Px and MUy / Py also slope downward.
Thus, when the consumer is buying OH of X and OK of Y, then
MUx / Px = MUy / Py = MUm

Therefore, the consumer is in equilibrium when he is buying 6 units of X and 4 units of Y. No

other allocation of money expenditure will yield him greater utility than when he is buying 6
units of commodity X and 4 units of commodity Y. Suppose the consumer buys one unit less of
good X and one unit more of good Y.
This will lead to the decrease in his total utility. It will be observed from Figure 7.2 (a) that the
consumption of 5 units instead of 6 units of commodity X means a loss in satisfaction equal to
the shaded area ABCH and from Fig. 7.2(b) it will be seen that consumption of 5 units of
commodity Y instead of 4 units will mean gain in utility equal to the shaded area KEFL. It will
be noticed that with this rearrangement of purchases of the two goods, the loss in utility ABCH
exceeds gain in utility KEFL.
Thus, his total satisfaction will fall as a result of this rearrangement of purchases. Therefore,
when the consumer is making purchases by spending his given income in such a way that MUx /
Px = MUy / Py , he will not like to make any further changes in the basket of goods and will
therefore be in equilibrium situation by maximizing his utility.
The Ordinal Utility Theory

The ordinal utility approach is a school of thought that believes that utility cannot be measured
quantitatively, that is, utility is not additive rather it could only be ranked according to
preference. The consumer must be able to determine the order of preference when faced with
different bundles of goods by ranking the various 'baskets of goods' according to the satisfaction
that each bundle gives. For instance, if a consumer derives 3 utils from the consumption of one
unit of commodity X and 12 utils from the consumption of commodity Y, this means that the
consumer derives more satisfaction from consuming commodity Y than from commodity X.
Though to the cardinals, the consumer derives four times more utility from one unit of Y than
from X. The ordinal utility theory explains consumer behaviour by the use of indifference curve.

Assumptions of Ordinal Utility Approach

(i) Rationality: - The consumer is assumed to be rational meaning that he aims at

maximizing total utility given his limited income and the prices of goods and services.

(ii) Utility is Ordinal: - According to this assumption, utility is assumed not to be measurable
but can only be ranked according to the order of preference for different kinds of goods.

(iii) Transitivity and Consistency of Choice: - By transitivity of choice, it means that if a

consumer prefers bundle A to B and bundle B to C, then invariably, the consumer must prefer
bundle A to C. Symbolically, it is written as:

If A > B and B > C; then A > C.

By consistency of choice, it is assumed that the consumer is consistent in his choice making. If
two bundles A and B are available to the consumer, if the consumer prefers bundle A to B in one
period, he cannot choose bundle B over A nor treat them as equal. Symbolically:

If A > B, then B > A and A ≠ B

(iv) Diminishing Marginal Rate of Substitution (MRS):- MRS is the rate at which the consumer
can exchange between two goods and still be at the same level of satisfaction. This assumption
is based on the fact that the preferences are ranked in terms of indifference curves which are
assumed to be convex to the origin.

(v) The Total Utility of the consumer depends on the quantities of the commodities consumed.
That is, the total utility is the addition of the different utilities. u = f(q1, q2 ----- qn)
(vi) Non Satiation: - it is assumed that the consumer would always prefer a larger bundle of
goods to a smaller bundle of the same good. He is never over supplied with goods within the
normal range of consumption.

Indifference Curve Analysis

Situations can arise when a consumer consumes a large number of goods, the consumer
may substitute one commodity for another and still be on the same level of satisfaction. As the
consumer increases the consumption of one of the commodities, he must reduce the consumption
of the second commodity and vice versa, to maintain the same level of satisfaction. When
plotted graphically, it gives rise to what is known as an indifference curve. An indifference
curve is defined as the locus of points representing different combination of two goods which
yield equal utility to the consumer so that the consumer is indifferent to the combination
consumed. When the preferences are plot graphically, it gives an indifference curve (Figure
4.1a). An indifference curve is also called iso-utility curve or equal utility curve. It is assumed
that the goods may not be perfect substitutes but if the commodities are perfect substitutes, the
indifference curve becomes a straight line with a negative slope (Figure 4.1b). And if the
commodities are complements the curve assumes the shape of a right angle (Figure 4.1c).

y
y y

IC
0 x
0 x 0 x
a b c

Figure 4.1: Different shapes of Indifference Curve

Let us illustrate the indifference curve using a consumer consuming two goods X and Y and
makes six combinations which yield the same level of satisfaction. If we assume a hypothetical
table with the different combinations of goods X and Y, the table could be regarded as an
indifference schedule.

Table 4.1 A Hypothetical Indifference Schedule

Combination Units of Units of Utility

commodity X commodity Y
a 3 28 u
b 6 23 u
c 10 16 u
d 18 12 u
e 26 8 u
f 30 5 u

When the combinations a, b, c, d, e, f are plotted on a graph, the resulting curve is known as
indifference curve. The indifference curve slopes downward from left to right showing that it is
convex to the origin.

Different sets of indifference curves give an indifference map. An indifference map (Figure 4.2b)
contains different number of indifference curves to show that the consumer may also choose
other combinations of goods X and Y. The combinations of goods on a higher indifference curve
yield higher level of satisfaction and are preferred. From Figure 4.2b, combination of goods X
and Y on IC3 is higher than the combination on IC2, while the combination on IC2 is higher than
the combination on IC1.
 y
y

30
.a
25
.b
20
.c
15
.d
10
.e .f IC3
5 IC IC 2
IC1
x x
5 10 15 20 25 30
(a) Indifference Curve (b) Indifference Map

Figure 4.2: A Graph showing an Indifference Curve and Map

Properties of an Indifference Curve

(1) Indifference curves are negatively sloped: - This negative slope shows that for a
consumer to stay on the same level of satisfaction, as the consumption of one commodity (X)
increases, the quantity of the other commodity (Y) must decrease. This reflects the marginal rate
of substitution. Marginal rate of substitution describes the rate of exchange between two
commodities. For our two commodities X and Y, the marginal rate of substitution of commodity
X for commodity Y denoted as MRSx,y is the rate at which commodity X can be substituted for
commodity Y, leaving the consumer at the same level of satisfaction. It is also known as the
negative slope of an indifference curve at any one point.

Slope of IC = - d d = MRSY,X 4.1

(2) Indifference curves must not Intersect: - If two indifferent curves intersect, it means two
different levels of satisfaction at the point of intersection. This situation is impossible because it
implies inconsistency in consumer’s choices. In other words, it nullifies the consistency and
transitivity of choice assumption.

(3) Upper indifference curve indicates a higher level of satisfaction: - An upper indifference
curve contains a larger combination of both commodities than a lower one and gives the
consumer a higher level of satisfaction.
 b
Quantity of Y

y a c
IC2

IC1

0 x
Quantity of X

Figure 4.3: Higher and Lower Indifference Curve.

Let us assume two commodities X and Y with different combinations. From Figure 4.3, there are
two indifference curves IC1, and IC2. A movement from point ‘a’ on IC 1 to point ‘b’ on IC2
indicates an increase in the quantity of commodity Y, while a horizontal movement from point
‘a’ to point ‘c’ on IC2 indicates an increase in the quantity of commodity X with the quantity of
commodity Y remaining constant. The combinations on point ‘b’ and ‘c’ on IC 2 yield higher
utility and will be preferred by the consumer.

(4) Indifference curve must be convex to the origin: - This shows that the slope of the
indifference curve decreases as we move along the curve from left to the right.

The Budget Constraint of the Consumer

The main objective of a rational consumer is to maximize his total utility by assigning his limited
resources (income). The consumer's ability to allocate these commodity bundles depends on the
prices of the commodities. The income and prices of the concerned commodities act as a
constraint to the consumer’s ability to consume the desired commodities. Jointly they form a
budget constraint and when graphed, it gives the budget line. Assuming our two commodities X
and Y with prices Px and Py respectively, if the consumer spends all the income on the two
commodities alone, the budget equation may be written as follows:

I = XPx + YPy 4.2

Where,

I = the income constraint of the consumer. X and Y quantities of commodities X and Y

respectively while Px and Py are the respective prices of commodities X and Y.

If the consumer decides not to buy commodity X and spend the whole income in consuming
commodity Y, then the quantity of Y demanded by the consumer will be:
QY = . 4.3

Similarly, If the consumer decides to spend the entire income in buying commodity X, then the
quantity of X demanded will be:
QX =
Therefore, equation 4.3 and 4.4 explains the points of intersection of the budget line at the
respective X and Y axis. The income constraint can be represented graphically with the budget
line as shown in Figure 4.3
y
I
Py

Budget line

Xpx + Yp y = I

I
Px

Figure 4.4: The Consumer’s Budget Line

Figure 4.4 show the budget line which places a constraint on the utility maximizing behaviour of
the consumer. The budget line shows the various combinations of goods that the consumer can
purchase with his limited income. The budget line is negatively slope showing that for the
consumer to have more of a commodity, he needs to have less of the other commodity. The slope

of the budget line is the ratio of the prices of the two commodities, that is:

Equilibrium Maximization of the Consumer

A rational consumer tries to attain equilibrium when he maximizes total utility given the
price of the goods and his income (budget constraint). This can be achieved simultaneously
under two conditions: The necessary (first order) condition and the sufficient (second order)
condition.

(1) The first order condition is that the marginal rate of substitution must be equal to the ratio
of commodity prices. That is,

MRSx,y = = 4.5

(2) The second order condition is that the indifference curve be convex to the origin. That is
the slope of the indifference curve decreases from left to right as we move along the curve which
is consistent with the axiom of diminishing marginal rate of substitution.

y
IC 3

IC2
IC 1

0 x B
Figure 4.5: Equilibrium of the Consumer

Figure 4.5 represents the indifference map of a consumer for various combinations of
commodities X and Y with the budget line AB. The consumer can afford to buy any of the
combinations within the budget line, but, cannot afford the combination outside the budget line.
The consumer will be in equilibrium by fulfilling both the first and second order conditions. The
first condition is that point of tangency of the curves and the budget line while the second order

condition is convex shape of the indifference curve. That is at the point where MRSx,y = =

. The consumer is in equilibrium at point D where the budget line intersects the highest

indifference curve IC2.