28 Jun 2019

PRINCIPLES OF MICROECONOMICS

           


                                                                                                                         

TABLE OF CONTENT


1.0     INTRODUCTION                                                                    2

2.0     THE DIFFERENCES BETWEEN CARDINAL UTILITY
AND ORDINAL UTILITY THEORY                                       6

3.0     CONSUMER EQUILIBRIUM                                                   9

4.0     CONCLUSION                                                                       12

          REFERENCES                                                                        13

1.0       INTRODUCTION
Utility analysis is a quantitative method that estimates the ringgit value of the benefits generated by an intervention based on improving it produces in worker productivity. Utility analysis provides managers with information they can use to assess the financial impact of an intervention, including the calculation of a return on their investment in its implementation.
The concept of utility was originally introduced by Brogden (1949) and Brogden and Taylor (1950) and developed by Cronbach & Gleser (1965). The concept has been studied and extended by Cascio (1982); Schmidt, Hunter, and Pearlman (1982); and Smither and Reilly (1983), among others. It was introduced as a method to evaluate the organizational benefits of using systematic procedures (eg proficiency testing) to improve personnel selection, but naturally extends to the evaluation of any intervention to improve human performance.
Average Utility is an average utility per unit of the good. It is calculated by dividing the total value by the number of units consumed. Marginal utility is the most to the total utility derived from the consumption of an additional unit of the good. The law of diminishing marginal utility, defined as more units of a good is consumed continuously and in standard units, the marginal utility from consumption of each additional unit will keep decreasing.
To understand the concept of utility applied to determine the balance of consumer understanding of the concept is crucial. The definition of use is the lack of power-satisfaction of a commodity. According to the Cardinal approach utility can be measured in number of cardinals such as 1, 2, 3 and 4. Meanwhile, total utility is the total satisfaction derived from the consumption of a good data units.
For this assignment, we will use the most basic product to explain the theory and the product equilibrium. Which is Apple and Orange fruits. To explain in simple way, assume that an orange is consumed. The marginal utility (and total utility) after eating one orange will be quite high. But if more oranges are eaten, the pleasure of each additional orange will be less than the pleasure we received from eating the one before - probably because we are starting to feel full or we have had too many fruits for one day. 

ORANGES
MARGINAL
TOTAL ORANGE
EATEN
ORANGE UTILITY
UTILITY
0
0
0
1
70
70
2
10
80
3
5
85
4
3
88

The table above shows that total utility will increase at a much slower rate as marginal utility diminishes with each additional oranges. Keep in mind that how the first orange gives a total utility of 70 but the next three oranges together increase total utility by only 18 additional units. 
Consumer equilibrium is defined as the situation where the utility of a consumer is maximized and that it does not tend to move. It can be analyzed in terms of unique product and many commodities as well. The balance of consumers in the context of a single product consumption refers to decisions that give the most satisfaction to the consumer. The level of consumption of the product is considered optimal if the consumption is more or less the worst consumer.
The analysis of marginal utility of consumer behavior suggests the rule of balancing the following application: the consumer is always better by buying more products of marginal utility exceeds its price, and less of a product the marginal utility is less than the price. The consumer has the benefit of a product whose marginal utility is equal to its price.
All consumers seek to maximize their utility and the selected product is two commodities that the most fundamental is the necessity these days, apple and orange. The preference of the consumer scale has been derived through mapping the difference of which is a set of indifference curves that class consumer preferences. Getting to the indifference curve which is farthest from the origin gives the highest total utility.

While consumer goal is the maximization of satisfaction, the means to achieve the objective are not clear. Higher indifference curve not only gives greater satisfaction, but also are more expensive. Here we are faced with the fundamental conflict between the preferences and the prices of raw materials consumer wants to consume. With a given amount of cash income for the past, we cannot achieve the greatest satisfaction, but must be content with less.

File:FigNo-1 Consumer's Equlibrium.jpeg
For an example, the above diagram shows that every combination on the price line GH cost the same amount of money. To maximize the utility, we will try to reach the highest indifference curve which you could get with a given expenditure of money and given prices of two goods. The budget line touches IC2 at point E represents the most utility.

This is the highest attainable indifference curve of which you can get good X OQ1 OQ2 units and units for Y r 50. Any other reasonable combination of the price line GH gives you less satisfaction, because it will be on a lower indifference curve IC1. With this, we conclude that the point of tangency between the budget line and an indifference curve is the optimal consumption. It is affordable combination that maximizes our utility.
2.0       THE DIFFERENCES BETWEEN CARDINAL UTILITY AND ORDINAL UTILITY THEORY
The concept of indifference curve was propounded in economics to replace the law of diminishing marginal utility. Marginal utility analysis is cardinal utility analysis and indifference curve analysis is ordinal utility analysis. These two concepts seen to be alternative. But, in reality, indifference curve has adopted some of the assumption of cardinal utility analysis. According to Edwin Marshal: The great 19th century economists like William Stanley jevons of England, Karl Menger of Austria, Leon Walras of France believed utility was measurable in cardinal sense. In contrast, most 20th century economists following the lead of E Slutsky, Vilfredo Pareto, Sir John Hicks assume that utility is measurable in an ordinal sense, which means that a consumer can only rank various market baskets with regard to the satisfaction they give him and her.

Utility refers to the satisfaction that the consumer obtains the purchase and use of goods and services. According to the economy there are two theories that are able to measure the satisfaction of individuals. It is the theory of cardinal utility and the theory of ordinal utility. There are a number of differences between the two in the methods they use to measure satisfaction in consumption. The following figure provides a clear explanation of each type of theory and highlights the main differences between cardinal utility and ordinal utility.









Cardinal Approach of Utility
Ordinal Approach of Utility

Cardinal approach is the one, which rests on the assumption that utility can be measured thereby implying that utility can be quantified.


For the purpose of measurement of utility the cardinal approach uses utils which help in understanding how much utility is derived from consumption of a product. Thus cardinal numbers are used to show the utility schedule.




The cardinal utility approach focuses on the independent utility derived from a product and hence any dependence is avoided.



Though this approach brings out the preference of one product over other through utils but this does not imply any conclusion or relation between the choices



Ordinal approach of utility does not give out any measurement unit which means that this approach does not consider the quantification of utility.


 As per ordinal approach, utility is used for grading/ranking of the products depending on the preferences of the consumer.



Here comparisons can be made of the utility derived from two products, but the utility cannot be computed quantitatively.


The ordinal approach will give a sense of preferences, likes and dislikes but there is no numerical measurement and this approach is used in grading the preferences of the consumer depending upon the alternatives that are available to him/her.

Figure 1: The distinction between Cardinal and Ordinal Theory

Measurement of utility. According to cardinal analysis, utility can be measured quantitatively. For example, the total utility derived from a commodity can be expressed as 20,30,40 units. Marginal utility can also be measured in similar way. But according to indifference curve analysis utility cannot be measured quantitatively, since utility is a psychological phenomenon.
Express preference. According to Cardinal analysis utility can be measured quantitatively. So a consumer can not only express preference. He can say that product X to Y is better, but it can also tell how much he prefers product X Y. But goods in ordinal utility, the consumer does not specify the quantity, but can say that satisfaction comes from a combination of products in high or low that other combinations.
Interest in product mix. In the cardinal's analysis, it is assumed that the consumer is interested in a good in a particular period time. Hence, most of his theories are based on the analysis of a commodity. But in the ordinal analysis, it is assumed that the consumer is interested in a combination of good. He may prefer a combination with any other or both combinations may be also preferable to him. He is said to be indifferent between two combinations. The curve on which combinations of same total return products presented is called indifference curve.
Observe preference. According to Cardinal analysis utility can be measured and at the same time consumer preference can be observed. For example, if a man buys orange and not buy Apple, we may say that prefers orange apple. According the ordinal analysis utility cannot be measured, but it is possible to observe the preference of the consumer. For example, if a consumer spends all his money on a combination instead of a combination B, we can say that he prefers a to B. Alternatively combination, we can say that he shot more satisfaction as a combination of the combination B.


3.0       CONSUMER EQUILIBRIUM         
The term consumer’s equilibrium refers to the amount of goods and services that the consumer can buy on the market taking into account his income and given the price of goods on the market. The consumer goal is to get maximum satisfaction from income money. Given the price line (budget line) and map of indifference, a consumer is said to be in equilibrium at a point where the price line is in contact with the highest indifference curve accessible from the figure 2 below.
Thus the consumer’s equilibrium under the indifference curve theory must meet the following two conditions. First is the order condition. A given price line should be tangent to an indifference curve or marginal rate of substitution of good X for good Y (MRSxy) must be equal P, to the price ratio of the two goods. MRSxy =Y.  The second condition is that indifference curve must be convex to the origin at the point of tangency.
There are a few assumptions in this concept that need to be taking noted. The following assumptions are made to determine the consumer’s equilibrium position:
1.      Rationality. The consumer is rational. He wants to obtain maximum satisfaction given his income and prices.
2.      Utility is ordinal. It is assumed that the consumer can rank his preferences according to the satisfaction of each combination of goods.
3.      Consistency of choice. It is also assumed that the consumer is consistent in the choice of goods.
4.      Perfect competition. There is perfect competition in the market from where the consumer is purchasing the goods.       












Figure 2: Consumer Equilibrium

We want to reach the highest indifference curve of our limited income. You can only go as far as your budget constraint allows. Suppose you have only RM 50 to switch to apple and orange. The price of an apple is RM 10, where the orange price is RM 5. You can have as many as 5 apples units if you want to give orange.
Similarly, you can have 10 units of oranges with the same RM 50. The budget constraints illustrate all combination of goods you can buy with a limited income. In this case the budget line illustrates the combination of apple and orange, that can be purchased with RM50.
The arrow indicates the point where equilibrium is reached consumers. A consumer may be able to buy three apples and four oranges with the allocated budget. The equilibrium occurs when it is bonded to two types of products.
Consumer equilibrium is achievable when Px = MUx/MUre for orange and Py = MUy/MUre for apple. This can be explained with the help of the following schedule.
A consumer has RM 88 with him. He wants to purchase orange and apple with his money. The market price of orange and apple is RM 8 per unit. The marginal utility schedule of orange and apple are given below.

Units of Good
MUx (orange)
MUy apple)
1
88(1)
40(7)
2
72(2)
36(8)
3
64(3)
24(10)
4
56(4)
20
5
48(5)
16
6
40(6)
12
7
32(9)
8
8
24(11)
4
9
16
0
10
8
(-)5

In case of two goods, a consumer strikes equilibrium when MUx/Py=MUy/Py or MUx/MUy=Px/Py. In this case, Px (orange) and Py (apple) are RM 8 per unit so that equilibrium will be arrived at when MUx = MUy or when MUx/MUy = 1. The equilibrium occurs when the consumer buys 8 units of orange and 3 units of apple. His total utility will be 424 utils form orange and 100 utils from apple, thus totaling 524 utils.
If he chooses any other combination orange and apple in order to maximize his total utility, then it will be either his money is not completely spent or he cannot afford to buy that combination because it is beyond his budget.

4.0       CONCLUSION        
The Utility theory is used to explain the behavior of individual customers. Marginal utility is the change of total utility with additional consumption of a product. The demand arises because of utility. The utility is measured as cardinal utility and ordinal utility. In cardinal utility, the utility can be measured objectively. And ordinal utility, usefulness is ranked according to preference by individual customers. The utility theory the customer's point of view, explains that in the law of diminishing marginal utility, which stipulates that the amount consumed by an individual for a product increases, the utility gained in additional units is decreasing. As the choice is limited by the price and the customer's income, a rational customer will not spend one additional unit of goods or services unless its marginal utility is equal or superior to that of a unit another product or service. The price of a product or service is linked to its marginal utility and the ranking will be given by the customer according to preferences.

In the conclusion, the two approaches have been used by economists throughout their existence, and it would not be fair to say an individual who is the best. Everything revolves around which to approach an individual to find what works best for their needs in a situation where economic analysis is required.






ATTACHMENT

REFERENCES
Brogden, H.E. & Taylor, E.K. (1950) The dollar criterion: applying cost accounting concepts to criterion selection. Personnel Psychology, 3, 133-154

Cascio,W. (1982) Applied Psychology in personnel management. Reston, VA: Reston Publishing Company (see Chapter 7, Utility: the concept and its measurement).

Cronbach, L.J. & Gleser, G.C. Psychological tests and personnel decisions. (2nd ed.), Urbana: University of Illinois, 1965.

Charlie, G. (n.d.). Cardinal Approach and ordinal approach in economics? Retrieved November 19, 2015, from http://science.blurtit.com/3284349/cardinal-approach-and-ordinal-approach-in-economics

Dagsvik, J.K. (2001) Compensated Variation in Random Utility Models. Discussion Paper No. 299, Statistics Norway.

Dooley, P. C. (1999). Slutsky's equation is Pareto's solution. Vilfredo Pareto: Critical Assessments of Leading Economists, 2(4), 289.

Hicks, J. R., & Allen, R. G. (1934). A reconsideration of the theory of value. Part I. Economica, 1(1), 52-76.

Lange, O. (1934). The determinateness of the utility function. The Review of Economic Studies, 1(3), 218-225.

Robert L.S (2011). Exploring Microeconomics, 6th Edition.  New York, US: Cengage Learning.

Reilly, Richard R. & Smither, James W. (1983) An examination of two alternative techniques to estimate the standard deviation of job performance in dollars. Journal of Applied Psychology, 70, 651-661.

Schmidt, F.L.; Hunter, J.E.; & Pearlman, K. (1982) Assessing the economic impact of personnel programs on workforce productivity. Personnel Psychology, 35, 333-347.

Sampat Mukherjee, Mallinath Mukherjee, and Amitava Ghose (2004). Microeconomics. New Delhi, India: PHI Learning Pvt. Ltd

Schultz, H. 1931. The Italian School of Mathematical Economics, Journal of Political Economy, 39.1: 76- 85.

Study Mode (n.d). Differences Between Cardinal and Ordinal Utility. Study Mode Website. Accesed on 18 November 2015, from: http://www.studymode.com/essays/Difference-Between-Cardinal-And-Ordinal-Utility-755130.html

Wikipedia (2015). Cardinal Utility. Wikipedia Foundation. Accessed on 18 November 2015, from: http://en.wikipedia.org/wiki/Cardinal_utility

Wikieducator (2015). Concept of Equilibrium. Wiki Educator Website. Accessed on 18 November 2015, from: http://wikieducator.org/CONSUMER%27S_EQUILIBRIUM


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