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The Law of Equi-Marginal utility (LEMU)

The idea of equi-marginal utility was first mentioned by H.H.Gossen (1810-1858) of Germany. Hence, it is called Gossen’s second Law of consumption. Alfred Marshall made significant refinements to this law in his ‘Principles of Economics’.
 
According to this law, the consumer will try to maximize his satisfaction when there are substitutes available in the market. So, he will substitute one item in place of the other such that his Marginal Utility is proportional to the price. The law of equi-marginal utility explains the behaviour of a consumer when he consumes more than one commodity. Wants are unlimited, but the income which is available to the consumer to satisfy all his wants is limited. This law explains how the consumer spends his limited income on various commodities to get maximum satisfaction.
 
According to Alfred Marshall, “Other things being equal, a consumer gets maximum satisfaction when he allocates his limited income to the purchase of different goods in such a way that the Marginal Utility derived from the last unit of money spent on each item of expenditure tend to be equal.”

Assumptions to Law of Equi-Marginal utility (LEMU)

  • The consumer is rational, so he wants to get maximum satisfaction
  • The utility of each commodity is measurable
  • The Marginal Utility of money remains constant
  • The income of the consumer is given
  • The prices of the commodities are given
  • The law is based on the law of diminishing marginal utility

Explanation of Law of Equi-Marginal utility (LEMU)

Suppose there are two goods, X and Y, on which a consumer has to spend a given income, the consumer being rational, will try to spend his limited income on goods X and Y to maximise his Total Utility or satisfaction. Only at that point of maximum satisfaction, the consumer will be in equilibrium. According to the law of equi-marginal utility, the consumer will be in equilibrium at the point where the utility derived from the last rupee spent on each item is equal.
 
Symbolically, the consumer will be in equilibrium when
 
Description: 19187.png
 
Where MUx = Marginal Utility of commodity X
MUy = Marginal Utility of commodity Y
Px = Price of commodity X
Py = Price of commodity Y
MUm = Marginal Utility of money
 
Let us illustrate the law of equi marginal utility with the help of the following table:
 
Suppose a lady has ₹ 5 with her, which she wishes to spend on two commodities, chocolates and ice creams. The marginal utility derived from both these commodities is as under:

 

Units of Money

MU of Chocolates

MU of Ice creams

1

10

12

2

8

10

3

6

8

4

4

6

5

2

3

₹ 5

Total Utility = 30

Total Utility = 39

 

A rational consumer would like to get maximum satisfaction from ₹ 5.00. She can spend this money in three ways.
  • ₹ 5.00 may be spent on chocolates only.
  • ₹ 5.00 may be utilized for the purchase of ice creams only.
  • Some amount may be spent on the purchase of chocolates and some on the purchase of ice creams.
If the prudent consumer spends ₹ 5.00 on the purchase of chocolates, she gets 30 utils. If she spends ₹ 5.00 on the purchase of ice creams, the total utility derived is 39 which is higher than chocolates. In order to make the best of the limited resources, she adjusts her expenditure.
  • By spending ₹ 4.00 on chocolates and ₹ 1.00 on ice creams, she gets 40 utils (10+8+6+4+12=40).
  • By spending ₹ 3.00 on chocolates and ₹ 2.00 on ice creams, she derives 46 utils (10+8+6+12+10=46).
  • By spending ₹ 2.00 on chocolates and ₹ 3.00 on ice creams, she gets 48 utils (10+8+12+10+8=48).
  • By spending ₹ 1.00 on chocolates and ₹ 4.00 on ice creams, she gets 46 utils (10+12+10+8+6=46).
The sensible consumer will spend ₹ 2.00 on chocolates and ₹ 3.00 on ice creams and will get the maximum satisfaction. When she spends ₹ 2.00 on chocolates and ₹ 3.00 on ice creams, the Marginal Utility derived from both these commodities is equal to 8. When the marginal utilities of the two commodities are equalized, the total utility is then maximum i.e., 48 as is clear from the schedule given above.
 
The law of equi-marginal utility can be explained with the help the diagrams.
 
Description: 19228.png
 
In the diagram, MU is the marginal utility curve for chocolates and KL of ice creams. When a consumer spends OP amount (₹ 2) on chocolates and OC (₹ 3) on ice creams, the Marginal Utility derived from the consumption of both the items (chocolates and ice creams) is equal to 8 units (EP=NC). The consumer gets maximum utility when she spends ₹ 2.00 on chocolates and ₹ 3.00 on ice creams and by no other alteration in the expenditure.
 
We now assume that the consumer spends ₹ 1.00 on chocolates (OC’ amount) and ₹ 4.00 (OQ’) on ice creams. If CQ’ more amount is spent on ice creams, the added utility is equal to the area CQ’ N’N. On the other hand, the expenditure on chocolates falls from OP amount (₹ 2) to OC’ amount (₹ 1.00). There is a toss of utility equal to the area C’PEE’. The loss in utility (chocolates) is greater than that of its gain in ice creams. The consumer does not derive maximum satisfaction except in the combination of expenditure of ₹ 2.00 on chocolates and ₹ 3.00 on ice creams.

Limitations of Law of Equi-Marginal utility (LEMU)

  • Rational behavior: It is true that consumer is irrational sometimes. It is behavior is greatly influenced by habits, advertisements etc.,
  • Cardinal Measurement of Utility: Critics point out that utility is an abstract term, which cannot be measured.
  • Utility is subjective: Utility is subjective and psychological concept. It is difficult to measure.
  • Marginal Utility of Money is not constant: Marshall assumes that marginal utility of money is constant but Hicks argues that money is also a commodity and the marginal utility also diminishes slowly.
  • Consumer is not a computer: a consumer has to keep a complete record of income and continuously calculate the marginal utilities but human mind is incapable of making such calculations.
  • Multiplicity: Multiplicity of commodities prevent the consumer from making a rational choice. He neither has time nor the ability to calculate marginal utilities.
  • Indivisible goods: It is not applicable to indivisible goods. There are certain goods such as fans, tv’s, car etc., which cannot be divided or sub divided. If divided they will lose their utility.
  • Durable goods: It is difficult to measure the utility in respect of durable goods such as car and machinery. For example; if the consumer purchases a refrigerator and a cup of coffee, it is very difficult to equalize the Marginal Utility of a refrigerator which lasts for several years with a cup of coffee, which exhausts at the single act of consumption.
  • Indefiniteness of budget period: The income may be daily, monthly or yearly. Even if we assume that budget period is one year, it is very difficult to calculate the utilities as he purchases various commodities.
  • Customs, fashions, ignorance, scarcity etc.: Customs make the consumption of an article compulsory irrespective of marginal utilities. Fashion of the day impede the operation of the law as one may purchase a commodity much against his wish to be in tune with the fashion. Consumer does not possess complete knowledge of all commodities and their prices in the market. Moreover prices are subject to change. Scarcity consumer is compelled to purchase an alternative or a substitute good if there is scarcity.

Importance of Law of Equi-Marginal utility (LEMU)

The Law of Equi-marginal utility is not only theoretical, but also has practical application in our daily life. Some of the areas, where it could be used are: -
  • The Theory of Consumption: The expenditure pattern of every consumer is based on this law. The consumer distributes his limited income among various commodities in such a way that the Marginal Utility or the satisfaction that he gets is equal to its price. At that point he stops further consumption, because he knows that if he continues consumption, the satisfaction will be less and the price he is going to pay is more. This helps the consumer to maximise his satisfaction.
  • Choice between Savings and Consumption: If the future consumption yields more satisfaction than the present consumption, in that case the consumer will decide to save his income rather than spending it.
  • The theory of production: The law helps the producer to maximise his profits by substituting one factor of production to another till the marginal productivity of all the factors are equalised.
  • The theory of public finance: The objective of public finance is to achieve maximum social advantage. The society gets the maximum economic benefit at the point where the sacrifice made by people on account of paying taxes is exactly equal to the benefits that they get from the government.
  • Exchange: a person having surplus, exchange with the person who has scarcity till marginal utility become equal.
  • Scarcity aspect: this law applies to all fields of economic activity where limited resources are to be profitably employed. Thus the law has very wide application. Prof. Marshall puts the significance of the law in the following words: “The application of this principle could be extended to every field of economic enquiry”.




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