Law of Equi-Marginal Utility

Law of Equi-Marginal Utility

Introduction of Marginal Utility

The Equi-Marginal Utility is simply an extension of the law of diminishing marginal utility for more than one commodity. The law of Equi-Marginal Utility is also known as the law of substitution, the law of maximum satisfaction, the law of indifference, and Gossen’s second law.

An Austrian economist H. Gossen presented the law of Equi-Marginal Utility in the 19h century.

According to the law of Equi-Marginal Utility,

“A consumer is in equilibrium when he distributes his given income among various goods in such a way that marginal utility derived from the last rupee spent on each good is the same.”

According to Lipsey,

“The households maximizing the utility will so allocate the expenditure between commodities that the utility of the last penny spent on each item is equal.”

According to Marshall,

“If a person has a thing which can be put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility.”

In the case of a single commodity, the consumer is in equilibrium when the marginal utility of any commodity is equal to its price. Symbolically, consumer equilibrium condition can be written as;

MU_x = P_x _________ (1)

In the case of more than one commodity, the consumer attains his or her equilibrium condition when he allocates his resources on different commodities that marginal utility from every next use should be greater or at least equal to the previous use.

                        Consumer Equilibrium = MU_x/P_x  =MU_y/P_{x _______________________________________}MUn/Pn

MU_x should be greater to or at least equal to MU_y.

ASSUMPTIONS OF THE LAW

The law of Equi-Marginal Utility holds under the following assumptions;

1. Cardinal Measurement

The utility must be measurable and can be expressed easily in numbers like 0, 2, 4, etc. So, total utility and marginal utility can be calculated.

2. Taste of Consumer:

The taste of the consumer remains unchanged during the consumption of goods. He does not prefer other commodities or rejects the old ones during consumption. The consumer must be rational as he urges to get maximum satisfaction from available resources.

3. Constant Marginal Utility of Money:

It is assumed that the MU of money remains constant otherwise it cannot result in the incorrect measurement of the marginal utility of the good.

4. Law of Diminishing Marginal Utility:

It is assumed that the consumption of a commodity by the consumer is subject to the law of diminishing marginal utility.

Explanation by an Example

Suppose a person has only 5 units of money to spend on two commodities, X and Y. The price of X commodity and Y commodity is $1 per unit. The marginal utility derived from both these commodities is as under;

 Schedule:

If a consumer spends 5 units of money purchasing commodity X, the total utility is 60 and if he spends 5 units on purchasing commodity Y, the total utility is 40 which is less than X commodity. A rational consumer will spend 3 units on X commodity and 2 units on Y commodity so that the marginal utility from both these commodities will be equal to 12. If Marginal utilities of the two commodities X and Y are totaled, the TU is 76 units,

TUx =20+16+12=48

TUy=16+12=28

TU_x + TU_y=48+28=76            [28 < 76 > 48]

The law of Equi-Marginal Utility can be explained with the help of the diagram.

We take units of money along the x-axis and the marginal utility of both commodities along the y-axis. When a consumer spends 3 units of money on X commodity and 2 units of money on Y commodity, the marginal utility from the spending of the last rupee on both commodities is equal to 12 units and the consumer gets the maximum satisfaction 76.

Hence, it is quite clear that there is no other pattern that provides maximum satisfaction to the consumer from his limited income other than the law of Equi-Marginal Utility.

LIMITATIONS OF THE LAW

There are some exceptions or limitations to the law of Equi- Marginal Utility.

1. The utility cannot be measured. In fact, utility relates to the state of mind of a person and cannot be stated in figures.
2. Consumption of drugs and intoxicants defies the law for a short period. The more a person drinks, the more he likes it.
3. The MU of money declines with richness but never fails to zero. The marginal utility of money is variable.
4. Due to the ignorance of consumers, cheap alternatives cannot be achieved and the consumer gets fail to attain maximum utility.

IMPORTANCE OF THE LAW

1. This law is basically for consumers who aim at maximizing their utilities. A consumer can maximize his TU by following this law. Therefore this law guides the consumers to get maximum utilities.
2. Producers can attain their objective of maximum profit. The law of Equi-Marginal Utility is the base for marginal productivity theory which is required for the process of maximization of profits.
3. This law guides finance authorities in framing the tax structure of the country. Also, it guides the allocation of funds for maximum productivity.
4. The marginal productivity theory is also a theory of distribution. By following this law, the distribution of wealth in the country will be just. This law is applied to all problems of scarce means against unlimited wants. Therefore, this law is equally important in other fields.