Demand : Marshallian’s Cardinal

Utility Analysis.
• The two approaches of Consumer Demand
Analysis:
1. Cardinal Utility/ Neo-Classical Approach
attributed to Alfred Marshall and his
followers.
2. Ordinal Utility/ Indifference Curve Approach
pioneered by J.R. Hicks, a Nobel laureate and
R.G.D. Allen.
 Cardinal Utility Analysis.
• Assumptions:
1. Rationality.
2. Utility is cardinally measurable...marginal
utility is actually measurable in terms of
money.
3. Utility is measured in imaginary units called
‘utils’.
4. Constant marginal utility of money.
5. Independent utilities.
6. Utility is additive.
7. Limited money income.
8. Maximisation of satisfaction.
9. Introspective method.
 Two important laws.
• Law of Diminishing Marginal Utility and
• Law of Equi-Marginal Utility.
Law of Diminishing Marginal Utility
• Marshall has stated the law as:
‘ 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.’
• It means that as a consumer takes more units
of a good, the extra/marginal utility that he
derives from an extra unit of the good goes on
diminishing.
• The marginal utility of a good is measurable in
terms of money that a consumer is willing to
pay for a unit of the good rather than he
without it.
• It is the marginal utility and not total utility of
a good that declines with the increase in its
consumption.
• Marginal utility of money is generally never
zero or negative.
• The law of diminishing marginal utility is
based on 2 important facts:
1. While the total wants of a man are virtually
unlimited, each single want is satiable.
2. Different goods are not perfect substitutes.
 Illustration
Cups of tea
consumed
Total Utility
(utils)
Marginal
Utility (utils)
• Moving down the table,
as consumption
increases, MU
1 12 12
diminishes.
2 22 10
• TU increases at a
3 30 8 diminishing rate
4 36 6 because of declining
5 40 4 MU.
6 41 1

7 39 -2

8 34 -5
 50 Total Utility Curve
• Up to the 6th cup of tea, TU 40
goes on increasing whereas
30 TU
after the 6th cup, it declines. T
•The MU of the additional U 20

cup up to the 6th cup is 10

positive whereas beyond the 0

6th cup, it is negative. 14
1 2 3 4 5 6 7 8

•The MU from the additional 12 Marginal Utility

10 Curve
cup of tea is diminishing. M 8
•TU rises up to a point & then U
6
declines due to negative MU. 4
2
0
-2 1 2 3 4 5 6 7 8
-4
-6 MU
 Principle of Equi-marginal utility/
Gossen Second Law
• This law determines consumer’s equilibrium.
• The law will be governed by 2 important facts:
1. Marginal utilities of the goods
2. Prices of the goods
• The law 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.”
• It means that consumer is in equilibrium
position when marginal utility of money
expenditure (MUe) on each good is the same.
• Consider two goods-X & Y-on which the
consumer has to spend a given income.
• MUe = MUx/Px
Where MUx= Marginal utility of good X,
Px=price of good X.
• According to the equi-marginal utility
principle, consumer will be in equilibrium in
respect of the purchase of goods X & Y, given
his income, when
MUx/Px = MUy/Py = MUe
• If MUx/Px > MUy/Py, consumer will substitute
good X for good Y thereby MUx will fall till
MUx/Px = MUy/Py again.
• How far a consumer will go on purchasing the
goods depends on the size of his income.
• Given consumer’s income, he has certain
marginal utility of money.
 Illustration
MU of good X and good Y Marginal utility of money expenditure
Units MUx MUy Units MUx/Px MUy/Py
1 20 24 1 10 8
2 18 21 2 9 7
3 16 18 3 8 6
4 14 15 4 7 5
5 12 9 5 6 3
6 10 3 6 5 1

•Given Px = Rs. 2, Py = Rs. 3, money income = Rs. 24.

•The equilibrium position where the consumer maximises his
utility is 10/2 =15/3 = 5
•The consumer spends (Rs.2 X 6+Rs.3 X 4)=Rs.24 on goods X & Y.
 GRAPHICAL REPRESENTATION
• CHECK NOTES
• Consumer’s equilibrium is where he is buying
OH of good X & OK of good Y.
• If he buys 5 units (OA) of good X & 5 units (OL)
of good Y, Total utility will decrease.
• Loss in utility ABCH exceeds gain in utility
KEFL.
• The principle of equi-marginal utility will hold
even when a consumer spends his money
income on several goods. Thus,
MUx/Px = MUy/Py =................=MUn/Pn = MUe
• Limitations
1. Difficulty in weighing marginal utilities of
different commodities.
2. Cardinal measurement of utility.
3. Indivisibility of certain goods.
 Derivation of the demand curve and
the law of demand.
Single commodity case • The law of diminishing
Fig.3 marginal utility states that
as the quantity of a good
M with a consumer increases,
U MU of the good to him
&P E
expressed in terms of
p
r E’ money falls.
P’
i • Consumer will go on
c
e purchasing a good till MU of
MU
the good equals the market
price.
0 Q1 Q2

Quantity
• Therefore the consumer will be in equilibrium
in respect of the quantity of a good purchased
where MU of the good equals its price.
• If price falls, downward sloping MU curve
implies a consumer buy more of the good till
MU of the good equals its price.
• Therefore, diminishing marginal utility curve
implies downward sloping demand curve, i.e.,
as the price of the good falls, more of it will be
bought.
2. Multi-commodity case (NO NEED).
• According to the law of equi-marginal utility,
given two goods, X & Y and money income, a
consumer will be in equilibrium when
MUx/Px = MUy/Py = MUe
Where MUx= Marginal utility of good X,
Px=price of good X, MUy= Marginal utility of
good Y, Py=price of good Y, MUe =marginal
utility of money expenditure.
• If, ceteris paribus, Px falls, consumer’s
equilibrium will be disturbed.
• MUx/Px > MUy/Py or Mue
• MUx must be reduced to attain equilibrium.
• This can be done by increasing consumption
of good X.
• Thus, as price of good X falls, quantity
demanded of it will rise which will make
demand curve downward sloping.
 Graphical explanation
Fig.4 •Given a certain income, the consumer
is in equilibrium buying Oq1 of good x
when price is Px1 & where marginal
utility of money OH is equal to
Mux
/Px MUx
MUx MUx/Px1.
/Px3
MUx
/Px 1
/P x2
MUe •When price falls to OPx2, the curve
H
will shift to MUx/Px2...equilibrium is
disturbed
•To attain equilibrium, MUx must fall
0 Quantity q1 which can be done by increasing the
q2 q3
consumption of x to q2.
D
•Thus, with the fall in the price of x,
A
P Px1 the consumer buys more of it.
r
I B •The lower portion of the figure shows
P x2
c the relationship between price and
e
Px3 C quantity demanded of x-the demand
D’ curve DD’.
0
q1 q2 q3
Quantity
 Critical evaluation.
• Cardinal measurability of utility is unrealistic.
• Hypothesis of independent utilities is wrong.
• Assumption of constant marginal utility of
money is not valid.
• Marshallian demand function cannot
genuinely be derived except in a one
commodity case.
• Cardinal utility analysis does not split up the
price effect into substitution and income
effects.
• Marshall could not explain Giffen paradox.
• Cardinal utility analysis assumes too much &
explains too little.
Thank you.