Law of Equi-Marginal Utility

CO2 Apply the concept of demand conditions and assess the position of a company.

Meaning

This law is based on the principle of obtaining maximum satisfaction from a limited
income. It explains the behavior of a consumer when he consumes more than one
commodity.

The law states that a consumer should spend his limited income on different
commodities in such a way that the last rupee spent on each commodity yield him
equal marginal utility in order to get maximum satisfaction.

Suppose there are different commodities like A, B, …, N. A consumer will get the
maximum satisfaction in the case of equilibrium i.e.,

MUA / PA = MUB / PB = … = MUN / PN

Where MU’s are the marginal utilities for the commodities and P’s are the prices of the
commodities.

Assumptions of the Law

· There is no change in the price of the goods or services.

· The consumer has a fixed income.

· The marginal utility of money is constant.

· A consumer has perfect knowledge of utility.

· Consumer tries to have maximum satisfaction.

· The utility is measurable in cardinal terms.

· There are substitutes for goods.

· A consumer has many wants.

Explanation of the Law:

· In order to get maximum satisfaction out of the funds we have, we carefully weigh
the satisfaction obtained from each rupee ‘had we spend If we find that a rupee spent in
one direction has greater utility than in another, we shall go on spending money on the
former commodity, till the satisfaction derived from the last rupee spent in the two
cases is equal.
· It other words, we substitute some units of the commodity of greater utility tor
some units of the commodity of less utility. The result of this substitution will be that the
marginal utility of the former will fall and that of the latter will rise, till the two marginal
utilities are equalized. That is why the law is also called the Law of Substitution or the
Law of equimarginal Utility.

· Suppose apples and oranges are the two commodities to be purchased. Suppose
further that we have got seven rupees to spend. Let us spend three rupees on oranges
and four rupees on apples. What is the result? The utility of the 3rd unit of oranges is 6
and that of the 4th unit of apples is 2. As the marginal utility of oranges is higher, we
should buy more of oranges and less of apples. Let us substitute one orange for one
apple so that we buy four oranges and three apples.

· Now the marginal utility of both oranges and apples is the same, i.e., 4. This
arrangement yields maximum satisfaction. The total utility of 4 oranges would be 10 +
8 + 6 + 4 = 28 and of three apples 8 + 6 + 4= 18 which gives us a total utility of 46.
The satisfaction given by 4 oranges and 3 apples at one rupee each is greater than
could be obtained by any other combination of apples and oranges. In no other case
does this utility amount to 46.

· We thus come to the conclusion that we obtain maximum satisfaction when we

· Diagrammatic Representation:

· In the two figures given below, OX and OY are the two axes. On X-axis OX are
represented the units of money and on the Y-axis marginal utilities. Suppose a person
has 7 rupees to spend on apples and oranges whose diminishing marginal utilities are
shown by the two curves AP and OR respectively.

· The consumer will gain maximum satisfaction if he spends OM money (3 rupees)

· Let the purchase spend MN money (one rupee) more on apples and the same
amount of money, N’M'( = MN) less on oranges. The diagram shows a loss of utility
represented by the shaded area LN’M’P’ and a gain of PMNE utility. As MN = N’M’ and
PM=P’M’, it is proved that the area LN’M’P’ (loss of utility from reduced consumption of
oranges) is bigger than PMNE (gain of utility from increased consumption of apples).
Hence the total utility of this new combination is less.

Limitation of the Law

There are some limitations to this law. They are

· The law is not applicable in case of knowledge. Reading books provides more
knowledge and has more utility.

· This law is not applicable in case of fashion and customs.

· There is no measurement of utility.

· Not all consumer care for variety.

· The law fails when there are no choices available for the good.

· The law fails in case of frequent price change.

Importance of the Law

· This law is helpful in the field of production. A producer has limited resources and
tries to get maximum profit.

· This law is helpful in the field of exchange. The exchange is of anything like some
goods, wealth, trade, import, and export.

· It is applicable to public finance.

· The law is useful for workers in allocating the time between the work and rest.

· It is useful in case of saving and spending.

· It is useful to look for substitution in case of price rise.

References:

Web Link

https://managedstudy.com/micro/law_of_equi_marginal_utility.htm