Discuss the cardinal utility theory. How do the cardinalists derive the demand curve? What are its drawbacks?
Cardinal utility theory, in microeconomics, is an effort to quantify the happiness or satisfaction economic consumption choices provide to consumers. This consumers' happiness or satisfaction is identified by the objectified economic term "utility": something has utility for the consumer to the degree or at the rate by which it provides (the utility of) happiness or satisfaction to the consumer. The idea of cardinal is opposite to that of ordinal: cardinalists believe in the quantifiability and measurability of consumers' economic experience of utility; ordinalists believe utility cannot be measured, cannot be quantified, because utility exists in "ordinal magnitudes" in which "bundles" of "baskets of goods" give comparative utility and because the consumer chooses between the magnitudes of comparative utility provided by various bundles of baskets of goods (Karnatak University, India). For some cardinalists, utility is measured in units of money because of the law of the constancy of the marginal utility of money (the utility of money is fixed and unchanging), whereas other cardinalists (the dominant school of cardinalists) measure utility in the imaginary unit of "utils."
Some assumptions are made in utility theory, one of which being that the consumer is rational and behaves in the marketplace in a rational manner. Consequently, the actions of a rational consumer in a marketplace are said to reflect the law of demand, which states that, when all other economic factors are held constant, there is an inverse relationship between price and demand wherein as price increases, demand decreases: demand for a good or service (when other factors are constant) is inversely dependent upon price. Cardinal utility theory approaches consumer demand from the standpoint of consumer utility, wherein demand is dependent upon factors of utility, price, income, substitutes and complementary goods.
Cardinalists derive the demand curve by assessing utility (U), total utility (TU), marginal utility (MU; marginal utility is the utility gained from one additional unit of a good), quantity demanded (Q/O), and price (P). Utility derived from a good increases as long as marginal utility (MU) is greater than price paid (MU > P). Utility reaches its apex, its equilibrium, where marginal utility equals price (MU = P). Utility diminishes when marginal utility is less than price paid (MU < P). The graphical representation of the increase, apex and diminishment of utility shows a parabola with the equilibrium quantity corresponding to the apex, which is reached before total utility (TU) begins diminishment with each added marginal unit of a good.
On a demand curve--for which each increment of marginal utility (MU) relates to an increment in price (P) and in which price inversely correlates to quantity demanded--the curve will be downward sloping because increases in quantity demanded correlate inversely to declining prices: as prices go downward, demand for the good goes upward (rightward).
The drawbacks (Karnatak University, India) of using cardinal utility theory to determine demand for a good, or for one bundle or another of baskets of goods, arise from the idea that the assumptions made by cardinal utility theory may or may not be sound. (1) The assumption that satisfaction can be objectively quantified with consistency in one individual or across a population of individuals is based on psychological and economic concepts that, when utility theory was founded, were then immature and that now inadequately reflect contemporary complexities. (2) Similarly, the concept of quantifying a subjective, seemingly impulse-based tendency toward liking or wanting seems poorly founded in scientific understanding (perhaps science and technology have now advance enough to overcome the problem of quantification of subjective impulses, but, if so, it seems it will still be a long while before such advances make an inroad into everyday economic analysis). (3) In our contemporary economy, the constant marginal utility of money is a concept that defies current reality since utility of money changes as the value of money changes (and that rather rapidly sometimes). (4) Marginal utility and diminishing utility are founded upon psychological principles that don't hold up as continuingly valid; new fields of psychology, such as the psychology of happiness, or positive psychology, shed new light upon the assumptions of marginal and diminishing utility underlying cardinal utility theory, which call the assumption into question ... although, with advances in scientific technology, the verdict may still be out on the true nature of these drawbacks.
The previous two answers have done a good job of explaining what cardinal utility theory is. I would like to briefly discuss the drawbacks of this theory as they are not clearly discussed in either answer.
In my view, the main problem with cardinal utility theory is that it is only possible in theory. I would argue that there is no real way to actually put cardinal utility theory into practice. Cardinal utility theory argues that it is possible to measure the amount of utility that a consumer gets from the consumption of any given good or service. However, this seems utterly impossible. There is no way to accurately measure the degree of satisfaction a person gets from a given economic transaction. You could ask a person to rank, on a scale of 1 to 100, how much satisfaction they got from a transaction, but that amount would be different for each person and would even differ from moment to moment for a given person.
Cardinal utility theory is useful as a way of getting us to think about consumer behavior, but it does not really give us any way to accurately measure consumer utility.
The concept of utility underlies all decision theory and rational choice modeling. It is foundational not only to economics, but also to game theory, political science, and other related disciplines.
The basic idea of utility is quite simple: We want some things more than other things. We think of some goods as "better" than other goods. Utility is an attempt to formalize this notion of preferring some goods over others in a way that can be applied mathematically.
Utility theory can broadly be separated into two types:
1. Ordinal utility, which is simply preferences themselves. A is better than B, B is better than C. That is all we can say; we cannot define something as "much better" or "slightly better" or "a large difference", because in ordinal utility these are strictly meaningless.
2. Cardinal utility, which was the original concept of utility. Goods give us a certain amount of happiness or satisfaction, and we prefer goods that give us more happiness to goods that give us less happiness. We could say that A is worth 100 utilons, while B is worth 50 and C is worth 20. Now we can make much more complex comparisons; we can say that 5 Cs should be equivalent to one A, for example, or that a 20% chance of an A is as good as having a C.
In fact, the Von Neumann-Morgenstern Theorem says that in order for behavior to be rational under conditions of risk, it must obey some form of cardinal utility function--ordinal utility is not enough. Moreover, Arrow's Impossibility Theorem shows that it is impossible to define the welfare of a society in purely ordinal terms. Again we must use cardinal utility in order to assess whether one society is doing better than another.
With respect to the third commenter, it is not impossible to measure cardinal utility; it is simply difficult. For many purposes it is not worth it, and ordinal utility will do; but for some purposes cardinal utility is necessary. How can we measure it? The simplest way is to use surveys, and just ask people questions like "Rate on a scale from 0 to 10 how much you like A, B, and C." (When Amazon.com and Netflix ask you to rate things in 1 to 5 stars, they are making a rough measurement of cardinal utility.) More precise methods involve measuring action potentials in the brain, part of the emerging field of neuroeconomics. We still do not have reliable precise measures of cardinal utility, but it is an ongoing field of research.
In economics, utility refers to the satisfaction or benefits consumer derive from consuming a product or service. The willingness of consumers to pay a given price for a product or service, and the choice of all the quantities of goods and services purchased by them depends on the quantity of utility they expect to derive from different goods. All such discussions of utility and its impact on demand and other economic behavior assumes that utility is a variable which can be measured and represented in terms of numerical cardinal quantities. This assumption of measurably of utility is not accepted by all economists. When utility as treated as something can be measured and its quantity represented in numbers, it is called cardinal utility. An alternate approach maintains it is possible to compare two different utilities and say which one is greater and which one is smaller, but it in not possible to assign a number to its quantity. Utility treated this way is called ordinal utility. The concept of ordinal utility implies that it is possible ti arrange different utilities according to the amount of satisfaction, but it is not possible to measure utility.
Utility is the satisfaction or pleasure that a person obtains from consuming a good or service. It is subjective because it depends on the taste and preferences of the individual consuming that particular good or service. As such, utility is a factor in the assumptions influencing consumer demand theory. And generally the consumer demand curve is sloped downwards because consumers' utility decreases as they consume more of a good or service. Consumer demand also decreases because consumers want to obtain as much satisfaction as possible at the lowest possible price; so when prices increase consumers reduce their purchases of that product.
Cardinal utility is countable. It is measured in a unit known as util, a quantifier of utility. Cardinal utility measurement approach is still mostly an economics theory that has not yet been fully applied to real economic situations. Basically for the cardinal approach, the consumer consumes two goods named S and T and as he or she consumes more of good S its utility decreases. The utility, however, of the less consumed good, good T, increases.