Law of Equi Marginal Utility:
“The household maximizing the utility will so allocate the expenditure between commodities that
the utility of the last penny spent on each item is equal”. The law of equi-marginal utility states
that the consumer will distribute his money income between the goods in such a way that the
utility derived from the last rupee spend on each good is equal. In other words, consumer is in
equilibrium position when marginal utility of money expenditure on each goods is the same.
Example and Explanation of Law of Equi-Marginal Utility:
The doctrine of equi-marginal utility can be explained by taking an example. Suppose a person
has $5 with him whom he wishes to spend on two commodities, tea and cigarettes. The marginal
utility derived from both these commodities is as under:
Schedule:
Units of Money MU of Tea MU of Cigarettes
1 10 12
2 8 10
3 6 8
4 4 6
5 2 3
$5 Total Utility = 30 Total Utility = 30
A rational consumer would like to get maximum satisfaction from $5.00. He can spend money in
three ways:
(i) $5 may be spent on tea only.
(ii) $5 may be utilized for the purchase of cigarettes only.
(iii) Some rupees may be spent on the purchase of tea and some on the purchase of cigarettes.
If the prudent consumer spends $5 on the purchase of tea, he gets 30 utility. If he spends $5 on
the purchase of cigarettes, the total utility derived is 39 which are higher than tea. In order to
make the best of the limited resources, he adjusts his expenditure.
(i) By spending $4 on tea and $1 on cigarettes, he gets 40 utility (10+8+6+4+12 = 40).
(ii) By spending $3 on tea and $2 on cigarettes, he derives 46 utility (10+8+6+12+10 = 46).
(iii) By spending $2 on tea and $3 on cigarettes, he gets 48 utility (10+8+12+10+8 = 48).
(iv) By spending $1 on tea and $4 on cigarettes, he gets 46 utility (10+12+10+8+6 = 46).
The sensible consumer will spend $2 on tea and $3 on cigarettes and will get maximum
satisfaction. When he spends $2 on tea and $3 on cigarette, the marginal utilities derived from
both these commodities is equal to 8. When the marginal utilities of the two commodities are
equalizes, the total utility is then maximum, i.e., 48 as is clear from the schedule given above.
Curve/Diagram of Law of Equi-Marginal Utility:
The law of equi-marginal utility can be explained with the help of diagrams.
In the figure 2.3 MU is the marginal utility curve for tea and KL of cigarettes. When a consumer
spends OP amount ($2) on tea and OC ($3) on cigarettes, the marginal utility derived from the
consumption of both the items (Tea and Cigarettes) is equal to 8 units (EP = NC). The consumer
gets the maximum utility when he spends $2 on tea and $3 on cigarettes and by no other
alternation in the expenditure.
We now assume that the consumer spends $1 on tea (OC/ amount) and $4 (OQ/) on cigarettes. If
CQ/more amounts are spent cigarettes, the added utility is equal to the area CQ/ N/N. On the
other hand, the expenditure on tea falls from OP amount ($2) to OC/ amount ($1). There is a toss
of utility equal to the area C/PEE. The loss is utility (tea) is greater than that The loss in utility
(tea) is maximum satisfaction except the combination of expenditure of $2 on tea and $3 on
cigarettes.
This law is known as the Law of maximum Satisfaction because a consumer tries to get the
maximum satisfaction from his limited resources by so planning his expenditure that the
marginal utility of a rupee spent in one use is the same as the marginal utility of a rupee spent on
another use.
It is known as the Law of Substitution because consumer continuous substituting one good for
another till he gets the maximum satisfaction.
It is called the Law of Indifference because the maximum satisfaction has been achieved by
equating the marginal utility in all the uses. The consumer than becomes indifferent to readjust
his expenditure unless some change fakes place in his income or the prices of the commodities,
etc.
Assumption of the Law:
The law of equi-marginal utility is based on the following assumptions;
The consumer is a rational economic man who seeks to maximize his total satisfaction.
Utility is measurable in cardinal terms.
The consumer has a given scale of preference for the goods in consideration. He has
perfect knowledge of utility derived.
Prices of goods are unchanged.
Income of the consumer is fixed.
Marginal utility of money is constant.
Wants and goods are substitutable.
Limitations/Exceptions of Law of Equi-Marginal Utility:
(i) Effect on fashions and customs: The law of equi-marginal utility may become inoperative if
people forced by fashions and customs spend money on the purchase of those commodities
which they clearly knows yield less utility but they cannot transfer the unit of money from the
less advantageous uses to the more advantageous uses because they are forced by the customs of
the country.
(ii) Ignorance or carelessness: Sometimes people due to their ignorance of price or carelessness
to weigh the utility of the purchased commodity do not obtain the maximum advantage by
equating the marginal utility in all the uses.
(iii) Indivisible units: If the unit of expenditure is not divisible, then again the law may become
inoperative.
(iv) Freedom of choice: If there is no perfect freedom between various alternatives, the
operation of law may be impeded.
