A Business Encyclopedia

Ordinal Utility

Definition: The Ordinal Utility approach is based on the fact that the utility of a commodity cannot be measured in absolute quantity, but however, it will be possible for a consumer to tell subjectively whether the commodity derives more or less or equal satisfaction when compared to another.

The modern economists have discarded the concept of cardinal utility and instead applied ordinal utility approach to study the behavior of the consumers. While the neo-classical economists believed that the utility can be measured and expressed in cardinal numbers, but the modern economists maintain that the utility being the psychological phenomena cannot be measured theoretically, quantitatively and even cardinally.

The modern economist, Hicks, in particular, have applied the ordinal utility concept to study the consumer behavior. He introduced a tool of analysis called “Indifference Curve” to analyze the consumer behavior. An indifference curve refers to the locus of points each showing different combinations of two substitutes which yield the same level of satisfaction and utility to the consumer.

Assumptions of Ordinal Utility Approach

  1. Rationality: It is assumed that the consumer is rational who aims at maximizing his level of satisfaction for given income and prices of goods and services, which he wish to consume. He is expected to take decisions consistent with this objective.
  2. Ordinal Utility: The indifference curve assumes that the utility can only be expressed ordinally. This means the consumer can only tell his order of preference for the given goods and services.
  3. Transitivity and Consistency of Choice: The consumer’s choice is expected to be either transitive or consistent. The transitivity of choice means, if the consumer prefers commodity X to Y and Y to Z, then he must prefer commodity X to Z. In other words, if X= Y, Y = Z, then he must treat X=Z. The consistency of choice means that if a consumer prefers commodity X to Y at one point of time, he will not prefer commodity Y to X in another period or even will not consider them as equal.
  4. Nonsatiety: It is assumed that the consumer has not reached the saturation point of any commodity and hence, he prefers larger quantities of all commodities.
  5. Diminishing Marginal Rate of Substitution (MRS): The marginal rate of substitution refers to the rate at which the consumer is ready to substitute one commodity (A) for another commodity (B) in such a way that his total satisfaction remains unchanged. The MRS is denoted as DB/DA. The ordinal approach assumes that DB/DA goes on diminishing if the consumer continues to substitute A for B.

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