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    Law of Equi-Marginal Utility

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    Anamika
    This document discusses the law of equi-marginal utility, which states that consumers will allocate their limited budgets in a way that equalizes the marginal utility, or satisfaction, received from each unit of expenditure. It provides assumptions of the law, explains how consumers substitute goods to maximize total utility given prices and budgets, and illustrates this with diagrams and an example involving apples and oranges. Finally, it discusses practical applications of the law in areas like consumption, production, exchange, and public finance, as well as limitations like ignorance, custom, and changing prices.

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    Law of Equi-Marginal Utility

    Uploaded by

    Anamika
    298 views5 pages
    This document discusses the law of equi-marginal utility, which states that consumers will allocate their limited budgets in a way that equalizes the marginal utility, or satisfaction, received from each unit of expenditure. It provides assumptions of the law, explains how consumers substitute goods to maximize total utility given prices and budgets, and illustrates this with diagrams and an example involving apples and oranges. Finally, it discusses practical applications of the law in areas like consumption, production, exchange, and public finance, as well as limitations like ignorance, custom, and changing prices.

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    Law of Equi-marginal utility

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    This document discusses the law of equi-marginal utility, which states that consumers will allocate their limited budgets in a way that equalizes the marginal utility, or satisfaction, received from each unit of expenditure. It provides assumptions of the law, explains how consumers substitute goods to maximize total utility given prices and budgets, and illustrates this with diagrams and an example involving apples and oranges. Finally, it discusses practical applications of the law in areas like consumption, production, exchange, and public finance, as well as limitations like ignorance, custom, and changing prices.

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    298 views5 pages

    Law of Equi-Marginal Utility

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    Anamika
    This document discusses the law of equi-marginal utility, which states that consumers will allocate their limited budgets in a way that equalizes the marginal utility, or satisfaction, received from each unit of expenditure. It provides assumptions of the law, explains how consumers substitute goods to maximize total utility given prices and budgets, and illustrates this with diagrams and an example involving apples and oranges. Finally, it discusses practical applications of the law in areas like consumption, production, exchange, and public finance, as well as limitations like ignorance, custom, and changing prices.

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    Dr. Anjali Prasad Topic:-Law of Equi-marginal utility.

    Department of Economics Class:-BA Part 1 Hons.


    TPS College, Patna

    Law of Equi-marginal Utility

    The Law of equi-marginal Utility is another fundamental principle of Economics.


    This law is also known as the Law of substitution or the Law of Maximum Satisfaction.
    We know that human wants are unlimited whereas the means to satisfy these wants are strictly
    limited. It, therefore’ becomes necessary to pick up the most urgent wants that can be satisfied
    with the money that a consumer has. Of the things that he decides to buy he must buy just the right
    quantity. Every prudent consumer will try to make the best use of the money at his disposal and
    derive the maximum satisfaction.

    Assumptions of Law of Equi-Marginal Utility

    • Units of goods are homogenous.

    • No time gap between the consumption of the different units.

    • Tastes, fashion, preferences, and priorities remain unchanged.

    • Consumer aims at maximum satisfaction.

    • Consumer’s income is fixed and limited.

    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 may take some other combinations
    and see.

    TABLE

    We thus come to the conclusion that we obtain maximum satisfaction when we equalize marginal
    utilities by substituting some units of the more useful for the less useful commodity. We can
    illustrate this principle with the help of a diagram.

    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) on apples and
    OM’ money (4 rupees) on oranges because in this situation the marginal utilities of the two are
    equal (PM = P’M’). Any other combination will give less total satisfaction.

    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.

    We then, conclude that no other combination of apples and oranges gives as great a satisfaction to
    the consumer as when PM = P’M’, i.e., where the marginal utilities of apples and oranges
    purchased are equal, with given amour, of money at our disposal.

    Limitations of the Law of Equimarginal Utility:


    Like other economic laws, the law of equimarginal utility too has certain limitations or exceptions.
    The following are the main exception.

    (i) Ignorance:
    If the consumer is ignorant or blindly follows custom or fashion, he will make a wrong use of
    money. On account of his ignorance he may not know where the utility is greater and where less.
    Thus, ignorance may prevent him from making a rational use of money. Hence, his satisfaction
    may not be the maximum, because the marginal utilities from his expenditure cannot be equalised
    due to ignorance.

    (ii) Inefficient Organisation:


    In the same manner, an incompetent organiser of business will fail to achieve the best results from
    the units of land, labour and capital that he employs. This is so because he may not be able to divert
    expenditure to more profitable channels from the less profitable ones.

    (iii) Unlimited Resources:


    The law has obviously no place where this resources are unlimited, as for example, is the case with
    the free gifts of nature. In such cases, there is no need of diverting expenditure from one direction
    to another.

    (iv) Hold of Custom and Fashion:


    A consumer may be in the strong clutches of custom, or is inclined to be a slave of fashion. In that
    case, he will not be able to derive maximum satisfaction out of his expenditure, because he cannot
    give up the consumption of such commodities. This is specially true of the conventional
    necessaries like dress or when a man is addicted to some intoxicant.

    (v) Frequent Changes in Prices:


    Frequent changes in prices of different goods render the observance of the law very difficult. The
    consumer may not be able to make the necessary adjustments in his expenditure in a constantly
    changing price situation.

    Practical Importance of the Law of Substitution:


    The law of substitution is of great practical importance. Everybody has got limited income.
    Naturally he must try to make the best use of it.

    This can be done by the application of this law in the various aspects of economic life as
    under:
    (i) Consumption:
    A wise consumer consciously acts on this law while arranging his expenditure. His expenditure is
    so distributed that the same price measures equal utilities at the margin of different purchases.
    Every person must try to spend his income in a manner which yields him the greatest satisfaction.
    This he will be able to do only if he spends his money in such a manner as to obtain equal
    satisfaction from the marginal units of money spent on the various commodities he purchases.

    (ii) Production:
    The law is also of great importance in production. The producer has to use several factors of
    production. He wants maximum net profit. For this purpose, he must substitute one factor for
    another so as to have the most economical combination, for example, he will substitute labour for
    machinery and vice versa, So that the marginal utility or marginal productivity of the two is
    equalised in this manner, he will get most economical combination of the ‘actors of production at
    his disposal to make maximum profit.

    (iii) Exchange:
    The law also applies in exchange because exchange is nothing else but substitution of one thing
    for another. When we sell a commodity, say, sugar, we get money. With this money, we buy
    another commodity, say, wheal. We have, therefore, really substituted sugar for wheat.
    (iv) Distribution:
    It is on the principle of marginal productivity that the share of each factor of production (viz., land,
    labour, capital, organisation) is determined. The use of each factor is pushed up to a point where
    its marginal product is equal to the marginal product of every other factor, of course after allowing
    for the differences in their respective remunerations. This necessitates substituting one factor for
    another.

    (v) Public Finance:


    The Government, too, is guided by this law in public expenditure. The public revenues are so spent
    as to secure maximum welfare for me community. The Government must cut down all wasteful
    expenditure while the return is not proportionate and instead concentrate its resources on more
    productive or more beneficial expenditure.

    (vi) Influences Prices:


    The law of substitution influences prices. When a commodity becomes scarce and its price soars
    high, we substitute for it things which are less scarce. Its price, therefore, comes down.

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