Question

Differentiate between the cardinal approach and the ordinal approach to the study of consumer demand theory.

Short answer

The cardinal approach assumes utility is measurable and quantifiable using cardinal numbers, relies on the concept of marginal utility, uses a numerical function for utility representation, and faces the Giffen goods paradox. In contrast, the ordinal approach assumes utility can only be ranked, uses the marginal rate of substitution, represents utility with indifference curves, explains income and substitution effects through the Slutsky Equation, and resolves the Giffen goods paradox. Overall, the ordinal approach is more prominent due to its realistic assumptions about consumer preferences.

Step-by-step solution

Define Cardinal Approach

The cardinal approach to consumer demand theory is based on the assumption that consumers have the ability to measure the level of satisfaction or utility they obtain from the consumption of a good or service. In this approach, utility is considered to be a measurable and quantifiable concept that can be expressed in cardinal numbers, such as 1, 2, 3, etc. This approach is primarily associated with classical economists like Alfred Marshall, who used concepts like the marginal utility and total utility to analyze the behavior of consumers.

Define Ordinal Approach

The ordinal approach to consumer demand theory assumes that consumers cannot measure utility in cardinal numbers. Instead, consumers can only rank their preferences for various goods or services in order of preference. That is, they can tell which good or service they prefer more, but they cannot quantify the difference in the level of satisfaction obtained from them. This approach is primarily associated with neoclassical economists, like John Hicks and R.G.D. Allen, who came up with the concepts of indifference curves and the marginal rate of substitution (MRS) to analyze consumer behavior.

Differences

1. Measure of Utility: The cardinal approach assumes that utility is measurable and can be expressed in cardinal numbers, while the ordinal approach assumes that utility can only be ranked in order of preference and not measurable in cardinal numbers. 2. Concept of Marginal Utility: The cardinal approach uses the concept of marginal utility to analyze consumer behavior. In contrast, the ordinal approach replaces the concept of marginal utility with that of the marginal rate of substitution (MRS) which shows the rate at which a consumer is willing to substitute one good for another to maintain an identical level of satisfaction. 3. Utility Function Representation: In the cardinal approach, the utility function can be represented using a numerical function, while in the ordinal approach, the utility function can be represented using an indifference map that shows a set of indifference curves. 4. Relevance of Income and Price Effects: The cardinal approach explains the income and substitution effects separately, while the ordinal approach combines both income and substitution effects in the Slutsky Equation. 5. Giffen Goods Paradox: The cardinal approach faces the paradox of Giffen goods, which are inferior goods where demand increases as the price increases. The ordinal approach resolves this paradox by introducing the concept of income and substitution effects. In conclusion, while both the cardinal and ordinal approaches are useful in understanding consumer demand theory, the ordinal approach has gained prominence due to its more realistic assumptions about consumers' ability to rank preferences rather than measuring them in cardinal numbers.

Key concepts

Cardinal Utility

Cardinal utility is a concept in consumer demand theory which assumes that utility, or satisfaction, can be quantified using numbers. Imagine eating an apple and feeling satisfied to a 'level 3'. You can measure utility with cardinal numbers in this approach, which allows for direct numerical calculation.
It is primarily associated with classical economists like Alfred Marshall.

This approach uses concepts like marginal utility to further understand consumer choices. Marginal utility shows how much additional satisfaction is gained from consuming one more unit of a good.
For example, if drinking a second cup of coffee gives you satisfaction "4", cardinal utility quantifies how much more enjoyment each cup of coffee provides.

• Measures utility in numerical terms.
• Relies on additional satisfaction (marginal utility).
• Useful for economic models that need numbers.

Ordinal Utility

Unlike cardinal utility, ordinal utility assumes consumers can't measure satisfaction with numbers. Instead, they rank their preferences. This means that a consumer can say whether they prefer apples over bananas, but not by how much more.
This theoretical approach is connected with neoclassical economists such as John Hicks.

The ordinal approach uses indifference curves to represent preferences without numerical values. Consumers can rank bundles of goods, but cannot express the utility difference between them.

• Utility is expressed as preference rankings.
• Influenced modern economic perspectives.
• Focuses on satisfaction levels rather than precise measures.

Marginal Utility

Marginal utility refers to the additional satisfaction gained from consuming one more unit of a product. It is a key principle in the cardinal approach to utility.
In practice, the first apple might provide a lot of satisfaction, but each successive apple provides less as hunger is satisfied.

Mathematically, it can be shown using the formula:\[MU(x) = \frac{\Delta U}{\Delta x}\]where \(MU(x)\) represents the marginal utility of good \(x\), \(\Delta U\) is the change in utility, and \(\Delta x\) is the change in quantity consumed.

• Measures additional happiness from one more unit.
• Diminishing returns often observed.
• Helps in understanding consumption patterns.

Indifference Curves

Indifference curves are used in the ordinal approach to demonstrate choices. They show different combinations of goods providing the same satisfaction level to a consumer. These curves do not cross, slope downwards, and are convex to the origin.
The consumer is equally satisfied on any point along a single curve, thus showing different combinations of goods that yield the same utility level.

These curves help in explaining concepts like the marginal rate of substitution (MRS) which indicates the rate at which a consumer would trade one good for another.

• Curves representing equal satisfaction levels.
• Useful for comparing bundles of goods.
• Highlights consumer’s preference trade-offs.

Marginal Rate of Substitution

The marginal rate of substitution (MRS) shows how much of one good a consumer is willing to give up for an additional unit of another, while keeping overall satisfaction the same.
It's a key concept in ordinal utility and is represented graphically as the slope of an indifference curve.

Mathematically, it's shown as:\[ MRS_{xy} = \frac{\Delta y}{\Delta x} \]where \(\Delta y\) is the change in the quantity of good \(y\), and \(\Delta x\) is the change in the quantity of good \(x\).

• Reflects trade-offs in consumption choices.
• Varies along the indifference curve.
• Reveals consumer preferences more intuitively.