Ordinal Utility Indifference Curve & MAP Characteristics of IC MRS & DMRS Shift in Budget Line Consumer Equilibrium

Price, Income and Substitution Effect

Roll No. 9 MBA-1st Semester

Anand Omar

Ordinal Utility theory

Ordinal utility theory states that while the

utility of a particular good and service cannot be measured using a numerical scale.

Different alternatives can be ordered into

worse, equal or better.

Goods are often considered in bundles or

baskets. For example, does individual A prefer 3 apples and 2 oranges or 3 oranges and 2 apples?

B C D

Characteristics of IC 1. Negative Slopping 2. Non Parallel & Non Intersecting A B

IC3

3. Upper Indifference means Higher Satisfaction 4. Convex to Origin 5. Never touches the X or Y axix C D

IC2 IC1

Marginal Rate of Substitution (MRS)

The MRS between two commodity, X & Y may be defined as the quantity of X which is required to replace one unit of Y or vice versa and total utility remains the same.

The Diminishing MRS

Indifference Point A B C D E Combination Change in Y Change in X Y+X ( Y) ( X) 25 + 5 15 + 7 10 + 12 6 + 20 4 + 30 ---10 -5 -4 -2 --2 5 8 10 MRS ( Y/ X) ---5.0 -1.0 -0.5 -0.2

Assumptions of Indifference Curve Analysis

Rational behavior of the consumer Scale of preference Concept of ordinal utility Consistency Preferences scale is independent of the market prices Transitivity Continuity

B Budget Line A

A E

Consumer Equilibrium
Consumer attains his/her equilibrium where he/she maximises his/her total utility, given his income and market prices of goods and services he consumes.
E

A J

Quantity of Y

Qy

Consumer is in Equilibrium at E
IC3 K IC2 IC1 B

Quantity of X

Price, Income & Substitution Effect

Price Effect Income Effect
M M P R IC1 Q IC2

= X1 X3 = X2 X3

Substitution Effect = X1 X2

}
N

X1 X2 X3

References: Managerial Economics D.N.Dwivedi Business Economics P.N. Chopra Various resources on Internet