Consumer Behaviour and Cardinal Utility (Consumer Theory and Meaning of Utility)

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Consumer Theory

Consumer theory is the study of how consumers decide to spend their money based on their individual preferences and budget.

Consumer theory is a branch of microeconomics.

Consumer theory shows how individuals make choices, how much income they have available to spend for goods and services.

Consumer behavior helps to understanding how consumers spend makes; it makes easier for vendors to predict which of their products will sell more

It also enables economists to get a better grasp of the shape of the overall economy

 

Consumer Behaviour

Economists have been interested to know the way how consumer’s behavior.

So, they have developed the consumer’s behavior theories.                 

Consumers’ behavior theories aim to explain, estimate and predict the market demand.

Market demand is the aggregate or summation of demand of all individuals at a point of time.

Analysis of individual demand refers to the explanation of the nature and conditions of consumers’ equilibrium.

Consumer’s equilibrium is the choice of appropriate commodity bundle, given money, income and prices.

It is related to the maximization of satisfaction or utility.

 

In the process, a consumer is not free to purchase any bundle of goods as he is constrained by resources.

So, the consumer theories aim to teach the consumer to maximize his/her satisfaction with subject to the constraints faced by him/her.

 

Consumer is the person who involves in the process of consumption of goods and services, whereas, consumption may be defined as a process of utilizing goods and services to fulfill human needs or to obtain satisfaction.

It generally refers to the use of goods and services to satisfy current needs.

Thus, consumption does not add value on goods and services rather it is a process of destruction of utility of goods and services.

 

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Meaning of Utility

In simple word, utility means usefulness.

In economics, utility is the capacity of a commodity to satisfy human wants.

In another words utility is the quality in goods to satisfy human wants.

Thus, consumer wants satisfying capacity of goods or services is called utility.

 

The starting point of consumer theories is governed by the notion of utility.

Utility word came to use widely in economics in the 19^th century.

The term used to record the level of happiness or satisfaction that consumer receives from the consumption of goods and services.

It is the human want satisfying power or quality of goods or services.

 

Two characteristics of the concept must be emphasized

First, utility and usefulness are no longer same.

Usefulness is closely related to the human welfare, whereas utility is limited only to the satisfaction of human wants.

For example, consumption of a bottle of wine by an alcoholic addict can fulfill his want but he cannot get welfare from the consumption of it.

 

Second, utility is a psychological phenomenon.

It resides on the mind of consumer.

Utility of goods may vary from person to person and different points of time to the same person.

For example, a bottle of wine may yield substantial utility to an alcoholic, but zero or negative utility to a non-alcoholic individual.

 

Cardinal Utility

Cardinal utility is the idea that economic welfare can be directly observable and be given a value.

For example, people may be able to express the utility that consumption gives for certain goods.

For example, if a Samsung mobile phone gives 650 units of utility, an iPhone would give 700 units.

Cordial utility is important for welfare economics which tries to put values on consumption.

We can express as formula i.e. Marginal cost = Marginal Utility.

One way to try and put values on goods utility is to see what price they are willing to pay for a good.

If we are willing to pay $700 for iPhone, we can suppose we must get 700 utils.

Utils is the unit of utilities.

In other words, the value of cardinal utility is related to the price consumers are willing to pay.

The idea of cardinal utility is important to rational choice theory.

This idea is based on that consumers make optimal choices to maximise their utility.

 

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Approaches to Utility Analysis

There are two approach of utility analysis; they are the cardinal and ordinal approaches.

(1) Cardinal Approach

Cardinal theory of utility analysis was developed by neo-classical economists; William Stanley Jevons, Leon Walrus, Carl Menger and perfected by Alfred Marshall in the 19^th century.

Cardinal theory of utility is also known as marginal utility analysis.

Marginal utility analysis is the central part of the theory.

 

This method assumes that the utility or level of satisfaction that the consumers derive from the consumption of goods and services can be measured in numbers just like height and weight.

The measuring unit of utility is ‘Utils’.

For examples, Ms Binita consumes four units of bread; she gets 4, 3, 2 and 1 units of utility.

 

(2) Ordinal Approach

This method of utility analysis assumes that utility cannot be measured in number but it can be ranked like first, second or more or less.

In our previous example, the satisfaction of Ms Binita cannot be written in specific number.

What we can say that she gets lesser and lesser satisfaction from the additional unit she consumes.

The detailed analysis of the ordinal approach is outside the scope of this book.

We take on the cardinal approach only.

 

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