Ordinal utility theory states that while the utility of a particular good and service cannot be measured using an objective scale; a consumer is capable of ranking different alternatives available. Goods are often considered in ‘bundles’ or ‘baskets’. For example, does individual A prefer 3 apples and 2 oranges or 3 oranges and 2 apples? When a large number of baskets of goods are compared, the preferences of the individual can be seen. This information is usually put together on a graph called an indifference map. One of these is shown below: A good in economics is any physical object (natural or man-made) or service that, upon consumption, increases utility, and therefore can be sold at a price in a market. ...
Image File history File links Indifference curve graphic was created by user:jrincayc to illistrate the indifference curve article. ...
Each indifference curve represents combinations of two goods or services which give the same level of utility to the consumer. The further a curve from the origin, the greater the level of utility. The slope of the curve (the Marginal Rate of Substitution of X for Y – MRSxy) shows the rate at which the individual trades off good X against good Y. The curve is convex to the origin due to diminishing marginal utility. The usual assumptions about rational economic man have to hold for the indifference curve approach to work. It can also be shown that indifference curves (an ordinal approach) give the same results as cardinal utility theory i.e. consumers will consume until the ratios between the marginal utility and the prices of all goods and services will be equal (the equi-marginal principle). In microeconomics, an indifference curve is a graph showing combinations of two goods to which an economic agent (such as a consumer or firm) is indifferent, that is, it has no preference for one combination over the other. ... Cardinal utility theory states that the utility (satisfaction) gained from a particular good or service can be measured in the same way as distance, temperature and time can. ...
Thus, utility theory assumes that any decision is made on the basis of the utility maximization principle, according to which the best choice is the one that provides the highest utility (satisfaction) to the decision maker.
In the former case, a utility function is used to derive a numerical score for each choice that represents the utility of this choice.
For instance, a utility of 100 units towards a cup of tea is twice as desirable as a cup of coffee with a utility level of 50 units.
A utility of 100 units towards a cup of vodka is twice as desirable as a cup of coffee with a utility level of 50 units.
For this reason, neoclassical economics abandoned utility as a foundation for the analysis of economic behaviour, in favour of an analysis based upon preferences.
A utility of 100 towards an ice-cream is not twice as desirable as a utility of 50 towards candy.
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