ME/U1 Topic 7 Cardinal Utility and Ordinal Utility
The Cardinal Utility approach is propounded by neo-classical economists, who believe that utility is measurable, and the customer can express his satisfaction in cardinal or quantitative numbers, such as 1,2,3, and so on.
The neo-classical economist developed the theory of consumption based on the assumption that utility is measurable and can be expressed cardinally. And to do so, they have introduced a hypothetical unit called as “Utils” meaning the units of utility. Here, one Util is equivalent to one rupee and the utility of money remains constant.
Over the passage of time, it was realized that the absolute measure of utility is not possible, i.e. it was difficult to measure the feeling of satisfaction cardinally (in numbers). Also, it was difficult to quantify the factors that cause a change in the moods of the consumer, their tastes and preferences and their likes and dislikes. Therefore, the utility is not measurable in quantitative terms. But however, it is being used as the starting point in the consumer behavior analysis.
The cardinal utility approach used in analyzing the consumer behavior depends on the following assumptions:-
It is assumed that the consumers are rational, and they satisfy their wants in the order of their preference. This means they will purchase those commodities first which yields the highest utility and then the second highest and so on.
- Limited Resources (Money)
The consumer has limited money to spend on the purchase of goods and services and thus this makes the consumer buy those commodities first which is a necessity.
- Maximize Satisfaction
Every consumer aims at maximizing his/her satisfaction for the amount of money he/she spends on the goods and services.
- Utility is cardinally Measurable
It is assumed that the utility is measurable, and the utility derived from one unit of the commodity is equal to the amount of money, which a consumer is ready to pay for it, i.e. 1 Util = 1 unit of money.
- Diminishing Marginal Utility
This means, with the increased consumption of a commodity, the utility derived from each successive unit goes on diminishing. This law holds true for the theory of consumer behavior.
- Marginal Utility of Money is Constant
It is assumed that the marginal utility of money remains constant irrespective of the level of a consumer’s income.
- Utility is Additive
The cardinalists believe that not only the utility is measurable but also the utility derived from the consumption of different commodities are added up to realize the total utility.
Thus, the cardinal utility approach is used as a basis for explaining the consumer behavior where every individual aims at maximizing his/her utility or satisfaction for the amount of money he spends on the consumption of goods and services.
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.
Key Differences between Cardinal and Ordinal Utility
The following points are noteworthy so far as the difference between cardinal and ordinal utility is concerned:-
- 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.
- Cardinal utility measures the utility objectively, whereas there is a subjective measurement of ordinal utility.
- 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.
- Cardinal utility, is based on marginal utility analysis. As against this, the concept of ordinal utility is based on indifference curve analysis.
- 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.
- Cardinal utility approach propounded by Alfred Marshall and his followers. Conversely, ordinal utility approach pioneered by Hicks and Allen.
These two above mentioned demand analysis approaches are not in competition with each other, but during the analysis of consumer behaviour, they represent two levels of sophistication. Both cardinal and ordinal utility are vital to assess and analyse consumer demand for a good or service, irrespective of the purpose.