Ordinal Utility Theory: Meaning & Assumptions

Meaning of Ordinal Utility Theory

J.R. Hicks and R.G.D. Allen, in 1934, propounded the theory of consumer behaviour based on the ordinal approach. According to this approach, a utility cannot be measured in any quantifiable number. It could only be measured by giving orders, ranks or preferences.

Hence ordinal utility means the consumer’s preferences or choice for one commodity or for a basket of goods over the other. Here, the preferences could be expressed in terms of ‘more’ or ‘less’ preferable.

Moreover, since the consumers have a limited income which they can spend on their consumption. Therefore, in this approach, a consumer will prefer a basket of goods over the other given the prices of the goods and the income of the consumer. This would be explained with the help of the budget line and indifference curve.

Assumptions of Ordinal Utility Theory

Rationality: A consumer is always rational, i.e., he always prefers more goods and services to derive maximum utility. Thus he always buys the commodity which gives him maximum utility first, and then he buys the least utility-giving commodity at the end.

Finite Money Income: The consumers have limited money income, which they spend on the purchase of all the goods and services for their living. Thus they allocate this income as their consumption expenditure on all goods and services.

Ordinal Utility: The utility derived from the consumption of each good or a basket of goods could be measured ordinally by giving preferences for each good over the other.

Transitivity and Consistency of Choice: The consumer’s preferences are always transitive i.e., if a consumer prefers good X over good Y and the same consumer prefers good Y over good Z then according to this assumption of transitivity, he must prefer good X over good Z also.

If, X>Y

If, Y>Z

Therefore, X>Z

Whereas as per consistency of choice, if a consumer prefers good X to good Y in one period then he must not prefer good Y to good X in another period or must not treat both the goods as equal.

Symbolically,

If, X>Y in one period

Then, Y>X or Y≠X in other period.

Non Satiety: According to this, a consumer always prefers more of a good or a larger quantity of all the goods because he has not reached the saturation level nor he is oversupplied with all the goods.

Diminishing Marginal rate of Substitution: Marginal rate of substitution refers to the rate at which a consumer substitute one good X for the other good Y so that the level of utility/ satisfaction obtained from it remains the same to him.

Symbolically,

MRS = ∆X/∆Y or ∆Y/∆X

According to this assumption, as a consumer continues to substitute X for Y or Y for X, his MRS diminishes/decreases.

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