EQUI MARGINAL UTILITY

In any maximization problem, there would be two different forces to reconcile: one that increases the
value of the objective function and another that reduces the value of the objective function as you go on
making small incremental increase in the values of the variables/ forces on which the value of the
objective function is dependent on. Naturally the value of the objective function (like profit or utility)
will be maximum when the impact on the objective function due to a small increase in the vbtwo
opposing variables are equal (like marginal cost=marginal revenue or marginal revenue product of labor
equals the wage rate or the marginal utlility from consumption equals the marginal cost of purchasing
the consumer item. In economics resource allocation problems (like housewife allocating the budgeted
expenditure among two goods or the firm allocating two inputs for producing a good), the value of the
objective function is maximized when the marginal benefit in terms of utility from each consumption
item or the marginal product of each input of production are equal. If they are not equal, one could
increase the value of the objective function (utility or the revenue) by increasinf the value of one
consumption item/ input item whose marginal benefit is higher by decreasing the quantity of
(consumption item/ input factor) whose marginal contribution to the objective function is lower. This is
the essence of equi-marginal (equality at the margin of costs and revenues or utility and purchase cost
or utility / productivity of different items being considered for allocation.
The Law of Equi-Marginal Utility is an extension to the law of diminishing marginal utility. The principle
of equi-marginal utility explains the behavior of a consumer in distributing his limited income among
various goods and services. This law states that how a consumer allocates his money income between
various goods so as to obtain maximum satisfaction. Assumptions The principle of equi-marginal utility is
based on the following assumptions: (a) The wants of a consumer remain unchanged. (b) He has a fixed
income. (c) The prices of all goods are given and known to a consumer. (d) He is one of the many buyers
in the sense that he is powerless to alter the market price. (e) He can spend his income in small
amounts. (f) He acts rationally in the sense that he want maximum satisfaction (g) Utility is measured
cardinally. This means that utility, or use of a good, can be expressed in terms of units or utils. This utility
is not only comparable but also quantifiable. Principle Suppose there are two goods 'x' and 'y' on which
the consumer has to spend his given income. The consumers behavior is based on two factors: (a)
Marginal Utilities of goods 'x' and 'y' (b) The prices of goods 'x' and 'y' The consumer is in equilibrium
position when marginal utility of money expenditure on each good is the same. The Law of Equi-
Marginal Utility states that the consumer will distribute his money income in such a way that the utility
derived from the last rupee spent on each good is equal. The consumer will spend his money income in
such a way that marginal utility of each good is proportional to its rupee. The consumer is in equilibrium
in respect of the purchases of goods 'x' and 'y' when: MUx = MUy Where MU is Marginal Utility and P
equals Price Px Py If MUx / Px and MUy / Py are not equal and MUx / Px is greater than MUy / Py, then
the consumer will substitute good 'x' for good 'y'. As a result the marginal utility of good 'x' will fall. The
consumer will continue substituting good 'x' for good 'y' till MUx/Px = MUy/Py where the consumer will
be in equilibrium. Thus this is also known as the law of substitution. Table Let us illustrate the law of
Equi-Marginal Utility with the help of a table: The side table shows marginal utilities of goods 'x' and 'y'.
Let us suppose that the price of goods 'x' and 'y' are Rs. 2/- and Rs.3/-. Then MUx/Px & MUy/Py are as
follows: With a given income a rupee has certain utility to him. This is the Marginal Utility for him. Now
the consumer will go on purchasing goods till the marginal utility of expenditure on each good becomes
equal to the marginal utility of money to him. Thus the consumer will be in equilibrium at a point where:
MUx = MUy = MUm MUm refers to Marginal Utility of Money Px Py Let us suppose that the given
income of a consumer is Rs.19/-. With the given income suppose the marginal utility of money is
constant at Rs. 1 = 6 utils. By looking at the above table, it is clear that MUx/Px = 6 utils when he buys 5
units of good 'x' and MUy/Py = 6 utils when he purchases 3 units of good 'y'. Therefore the consumer
will be in equilibrium when he is buying 5 units of good 'x' and 3 units of good 'y' and will be spending
Rs.19/- on them. MUx/Px = MUy/Py = MUm 12/2 = 18/3 = 6 Graph This law can be explained with the
help of the following diagram: In the above diagram marginal utility curves of good 'x' & 'y' slope
downwards. Marginal Utility of Money is confident at OM. MUx/Px = OM when OK amount of good 'x' is
purchases and MUy/Py = OM when OH amount of good 'y' is purchased. Thus the consumer will be in
equilibrium when he purchases OK amount of good 'x' and OH amount of good 'y' and then: MUx/Px =
MUy/Py = MUm Limitations This law is based on the assumption that utility can be cardinally
measurable. But in actual practices it cannot be measured in such cardinal numbers. It is also assumed
that marginal utility of money is constant. But this is not true because when the quantity of money
increases, its marginal utility will diminish. This law is not applicable in the case of indivisible goods like
TV sets, refrigerators, etc. Normally a person will buy only a single unit of such goods. Hence it is
ridiculous to prepare an individual marginal utility schedule for such goods. However, this principle is
useful to a consumer to obtain maximum satisfaction and it is also helpful to a producer to get
maximum profits.