Law of equi-marginal utility
It is a classical theory of consumer behavior, law of substitution in consumption or maximum satisfaction.
STATEMENT OR DEFINITION OF LAW:
The law of equi-marginal utility states that “A rational person in order to get maximum satisfaction allocates his expenditures on purchase of different goods in such a way that marginal utility of the last Rs. Spent in each direction is the same”.
This is called the law of satisfaction because we substitute more useful goods to less useful goods. This is called the law of maximum satisfaction because through it we get maximum satisfaction and it is called the law of equi-marginal utility because through it when the marginal utilities are equalized, through the process of substitution, the maximum satisfaction is attained.
EXPLAINATION WITH THE HELP OF SCHEDULE:
The law can be explained with the help of schedule.
A hypothetical person has to spend Rs. 7. He is going to buy two commodities A & B. the price of each commodity is Rs. 1 unit. Our hypothetical consumer is a rational person.
Rs. MU of commodity A MU of commodity B
1 40 35
2 35 30
3 30 25
4 25 20
5 20 15
6 15 10
7 10 05
SUM 175 140
It is clear from the above scheduling that when our hypothetical consumer spends Rs. 4 on commodity ‘A’ and Rs. 3 on commodity ‘B’. The marginal utilities are equal at that point. The total utility is 220, which is maximum in any other case.
Suppose, 6 rupees spend on ‘A’ and 1 rupee on ‘B’ [40+35+30+25+20+15+35 = 200]
If he changes his plan i.e. spends more on commodity ‘B’ and less on commodity ‘A’. The marginal utilities would not be equal and he would not gain maximum satisfaction. The total utility would also be less in any case other than when the marginal utilities are equal and satisfaction is maximum.
EXPLAINATION WITH THE HELP OF DIAGRAM:
In this figure on the axis OX is the quantity of commodity ‘A’ and on the axis OX¢ is the quantity of good ‘B’ on the axis OY is the marginal utility of the amount of money spend on goods ‘A’ and ‘B’.
It is clear that when consumer spends Rs. 4 on good A and Rs. 3 on good B. The marginal utilities are same and satisfaction is maximum. On the right side of OY is the curve UA that represents the MU of A
and is down ward sloping from left to right.
On the left hand side of OY is the curve of UB which represents the MU of B and is also down ward
from right to left. If the consumer spends more Rs On commodity A and less on commodity B the
marginal utilities are not equal and satisfaction is less e.g. if he spends 5 on commodity B and 2 on commodity A OR spends 3 on A and 4 on B the satisfaction is not maximum.
It can be shown with the help of a figure.
In both figures the gain in utility is less than the first and the satisfaction is also decrease.
Following are the assumptions of the law.
The marginal utilities of different commodities should be independent of each other and diminishes with more and more purchase.
Marginal Utility of Money:
The marginal utility of money should remain constant for the consumer as he spends more and more of it on the purchase of goods.
Every consumer should be rational in the purchase of goods. His aim should be to maximize the total utility and nothing else.
Substitution of Goods:
It is assumed that goods are naturally substitutes of each other. The result of substitution will be the MU of one commodity will fall and that of another commodity will rise.
Awareness of Market:
It is assumed that consumer has much awareness about the market.
Divisibility of Goods:
The law is based on the assumption that goods are divisible in small units.
CRITICIZM OR LIMITATIONS:
Following are the limitations of the law.
No Rational Calculation:
The law involves rational calculations. But in the busy and routine life we are not capable to do so that who is rational and who is irrational.
The consumer may not aware of the goods which are more useful than the goods which they are going to purchase. So, they cannot substitute more useful goods to the less useful goods and hence the law is not applicable to them.
Indivisibility of Goods:
Sometimes the goods are not divisible to small units. So MU cannot be calculated and law is not applicable.
It assumed that utilities are measurable but in actual utility cannot be calculated because it is a state of mind. It is assumed that marginal utility of money remains constant but the law of DMU applies to money equally.
® This law is applied to all problems of scarce (limited) resource against unlimited wants.
® This law plays an important role in the theory of distribution and exchange.
® It extends over the field of the theory of production.
Thus the law of substation applies in all branches of economic theories.