Chapter -1

Utility Analysis
➡️Question 2- Explain the Law of Equi-Marginal
utility and indicate its significance in
Economics. Or
State the law of Equi-Marginal Utility with its
limitations.
➡️ Answer-Meaning
Law of equi-marginal utility is the second important law of utility analysis. This law
points out how a consumer can get maximum satisfaction out of his given expenditure
on different goods. This law concerning the expenditure of a consumer was first
propounded in 19th century by a Frenc engineer Gossen. It is therefore also known as
'Second Law of Gossen'. Dr. Marshall has called Law of Equi-marginal Utility. The law
states that in order to get maximum satisfaction, a consumer should spend his limited
income on different commodities in such a way that the last rupee spent os each
commodity yields him equal marginal utility. Economists have given different names
to this law.

➡️Definition
According to Prof. Samuelson, "A consumer gets maximum satisfaction when
the ratio of marginal utilities of all commodities and their price is equal."
➡️ Assumptions
🔹Cardinal measurement of utility is possible.
🔹Consumer is rational, that is, he wants maximum satisfaction from his income.
🔹Income of the consumer remains constant.
🔹Marginal utility of money remains constant.
🔹Prices of the commodities remain constant.
🔹Commodity is divisible into small units. It means that the consumer can spend his
income in small units of money, say, one rupee.
🔹Consumption takes place at a given time period.

➡️Explanation
The law can be explained with the help of Table and Fig. Suppose the income of a
person is 5 only. He wants to spend it on two goods, say, mangoes and milk. Let us
suppose that price of both the goods is & 1 per kg/L. Marginal utilities of different units
of mangoes and milk are shown in Table .

🔴Table . Law of Equi-Marginal Utility

Rupees Spent MU of 🥭🥭 MU of 🥛🍼

1st 12 10

2nd 10 8
 3rd 8 6

4th 6 4

5th 4 2

Suppose, the consumer spends his income in terms of one-rupee unit. The first rupee
spent on mangoes yields him 12 utils worth of marginal utility and the first rupee
spent on milk yields him 10 utils worth of marginal utility. He will, therefore, spend
first rupee on mangoes. Out of the second and third rupee, he will spend one on milk
and the other on mangoes. Thus, to get maximum satisfaction out of his income of &
5, the consumer will spend & 3 on mangoes and & 2 on milk. Third rupee spent on
mangoes yields him 8 utils worth of marginal utility and second rupee spent on milk
also yields him 8 utils worth of marginal utility. Thus, the last unit of money spent on
both commodities gives the consumer equal marginal utility. This mode of distribution
of his income will
yield the consumer maximum satisfaction. Utility from mangoes = 12 + 10 + 8 = 30
utils. Utility from
mik= 10 + 8 = 18 utils. Total utility = 48 utils. In case the consumer spends his
income in any other
manner, then he will get less total utility.
 MARGINAL UTILITY

Caption

➡️Importance of the Law

🔹Consumption:
Every consumer wants to get maximum satisfaction from his limited means. If a
consumer spends his income, as suggested by this law, on different commodities in
such a way that the last unit of money spent on them yields him equal marginal utility,
then he will be getting maximum satisfaction out of his income.
🔹Production:
Every producer aims at earning maximum profit. To achieve this objective he must
utilise different factors of production, i.e., land, labour, capital, etc., in such a way that
the marginal productivity of each factor is equal.

🔹Exchange:
Exchange implies replacing of goods giving less utility with goods giving more utility
Acting upon the law of equi-marginal utility, every persone will go on substituting
goods giving more utility for the ones giving less utility, till the marginal utility of al
becomes equal. Exchange will stop at that point.

🔹Distribution:
It refers to the distribution of national income among the factors of production, ie,
land, labour, capital, etc. Distribution is done in such a way that in the long-run every
factor gets its share out of national income according to its marginal productivity .To
have such a distribution, factors are to be mutually substituted in a manner that the
marginal productivity of each factor is equal to its remuneration, and the marginal
productivity of different factors becomes equal to each other.

🔹 Distribution of Income between Saving and

Consumption:
According to this law, income should be so distributed between consumption and
saving, that the last unit of money spent on the present consumption should yield the
same utility as the last unit of money kept in the form of saving. Such a distribution is
called optimum allocation.

🔹Optimum Distribution of Commodities:

In a free market economy, optimum distribution of commodities can be made possible
with the help of this law. Optimum distribution of commodities refers to that
distribution, a slight change whereof may diminish the total utility enjoyed by the
society as a whole. Optimum distribution becomes possible when a commodity is
distributed among different persons in such a way that the marginal utility derived by
each person becomes equal.

🔹 Distribution of Assets:
This law helps people distribute their assets in different forms.Suppose a person has
cash assets worth rupees one lakh. He wants to invest it in different forms, such as,
bank deposit, bonds, stocks, shares, housing, etc. According to this law, investment
should be made in different forms of assets in such a way that last unit of money
invested in each form should yield equal marginal utility.

🔴Limitations🔴
🔹Consumers are Not Fully Rational:
The assumption that consumers are fully rational is not correct. Some consumers are
idle by nature, and so to satisfy their habits and customs, they sometimes buy goods
yielding less utility. Consequently, they do not get maximum satisfaction.

🔹Consumer is not Calculating:

The law is based on the wrong assumption that while spending his income a consumer
constantly calculates the utility derived by him out of each rupee spent. Another
wrong assumption of the law is that the consumer goes on comparing the marginal
utilities of the last rupee spent on different commodities. In actual life one hardly
comes across such a calculating consumer. So the application of the law is practically
difficult.

🔹Shortage of Goods:
If goods giving more utility are not available in the market, the consumer will have to
consume goods yielding less utility. For instance, if cooking gas is not available one
has to use either coal or kerosene oil. If the utility of the latter is less than that of
cooking-gas, one will not get maximum satisfaction.

🔹Influence of Fashion, Customs and Habits:

Actual expenditure of every consumer is influenced by fashion, customs and habits.
Under their influence, many a time consumer buys more of such goods which give less
utility. Consequently, he buys less of those goods which give more utility. Hence, he
fails to spend his income according to this law.

🔹Ignorance of the Consumer:

Consumer is ignorant about many things concerning consumption. Many a time, he is
ignorant about the right price of the goods. He is ignorant about the less expensive
substitutes of the goods. He is ignorant about the different uses of the goods. On
account of this ignorance, the consumer fails to spend his income in a manner that
may yield him maximum satisfaction.
🔹Indivisibility of Goods:
The law does not apply to those goods which cannot be divided into small parts. We
have to buy at least one unit of, say car, LED TV, scooty, etc. In order to equalise the
marginal utility of different goods, if we are supposed to buy more than one unit of the
above goods, then it may not be possible for us to buy the additional unit.
Consequently, the law does not apply to indivisible goods.

🔹Constant Income and Price:

According to Leftwitch, an important limitation of the law is that the income of the
consumer and the price of the goods should remain constant.
Income of the consumer is limited, as such he cannot increase his satisfaction beyond
a particular limit.

🔹Indefinite Budget Period:

Another limitation of the law is that the budget period of the consumer is not definite.
Budget period refers to that period in which a consumer has to spend his income of
different uses. It may be a month or an year. Some goods like, LED TV, refrigerator,
etc., are bought in one budget period, but they continue to yield utility over many
budget periods. Marginal utility of such goods cannot be compared with the marginal
utility of those goods which are bought and consumed in the same budget period.

🔹Complementary Goods:
The law does not apply to complementary goods. It is so because, complementary
goods are used in a fixed proportion. By using less of one commodity, use of the other
cannot be increased. For example, laptop case along with laptop, and SIM Card along
with smart phone will have to be purchased.