Ordinal Utility Approach:
The basic idea behind ordinal utility approach is that a consumer keeps number of pairs of two commodities in his mind which give him equal level of satisfaction. This means that the utility can be ranked qualitatively.
The ordinal utility approach differs from the cardinal utility approach (also called classical theory) in the sense that the satisfaction derived from various commodities cannot be measured objectively.
Ordinal theory is also known as neo-classical theory of consumer equilibrium, Hicksian theory of consumer behavior, indifference curve theory, optimal choice theory. This approach also explains the consumer's equilibrium who is confronted with the multiplicity of objectives and scarcity of money income.
The important tools of ordinal utility are:
- The concept of indifference curves.
- The slop of I.C. i.e. marginal rate of substitution.
- The budget line.
The ordinal utility approach is based on the following assumptions:
- A consumer substitutes commodities rationally in order to maximize his level of satisfaction.
- A consumer can rank his preferences according to the satisfaction of each basket of goods.
- The consumer is consistent in his choices.
- It is assumed that each of the good is divisible.
- It is assumed that the consumer has full knowledge of prices in the market.
- The consumer's scale of preferences is so complete that consumer is indifferent between them.
- Two commodities are used by the consumer. It is also known as two commodities model.
- Two commodities X and Y are substitutes of each other. These commodities can be easily substituted in various pairs.