EQUI-MARGINAL CONCEPT

INTRODUCTORY TERMS:

UTILITY:- In simple words, utility means satisfaction.

MARGINAL UTILITY:- The increment to the utility caused by an additional
unit of a commodity
Eg. If we are consuming ice cream, the first unit of ice cream will give a certain
level of satisfaction or utility. When we are having a second ice cream, we will
get some additional satisfaction or utility, but not to the same extent (value) as in
the initial case. This additional satisfaction or the increment to the utility is
called the marginal utility.

Therefore the “marginal” is a key term in economics and always means extra
Definition: Marginal Utility is defined as the additional utility arising from
consumption of an additional unit of commodity.

Relationship between Total & Marginal Utility

We can take a numerical example to illustrate various utilities. Let us consider
the following table:
Quantity of goods Total utility [ U ] Marginal utility
consumed [ Q ] [ MU ]

0 0 0
1 4 4
2 7 3
3 9 2
4 10 1
5 10 0
From the table, it is clear that total utility (U) increases with consumption (Q),
but the fact is that it is increasing with a decreasing rate. It is also noticed that
marginal utility declines with each additional unit consumption which points out
to Diminishing Marginal Utility.

The graphical representation of the above table is given below:

The law of diminishing marginal utility is implied by the marginal utility curve,
sloping downward. The total utility curve looks like a dome, a concave nature
which shows that total utility is increasing but with a decreasing rate for each
additional unit of consumption.
Note- The area under smooth MU curve is equal to the height of the total utility
curve (U-curve) for the same no. of units as in the shaded portion.

CONCEPT OF EQUI-MARGINAL PRINCIPLE – EQUAL MARGINAL

UTILITIES PER DOLLAR FOR EVERY GOOD

The marginal utility analysis enables one to have microscopic examination of

each unit-by-unit changes on the cost o& revenue of the commodity. The
marginal utility analysis can now be used to explain how a rational consumer
will allocate a given amount of spendable income among different goods he has
already decided to buy to achieve maximum utility. The law of equi-marginal
utility is a rule to determine the optimum (best) allocation of a given amount of
income among different goods.

The law of equi-marginal utility states that “a consumer will derive the
maximum utility from a given level of spendable income when the ratio of
marginal utility to the price is the same for all goods.”
If the given amount of income is allocated between two goods, law of equi-
marginal utility requires MU1/P1 = MU2/P2.
[ MU1 – additional utility derived from one extra unit of product no. 1
P1 – Price tag of product no. 1]
Ie. By spending P1, consumer gets MU1 of utility. Then by spending Re 1,
consumer gets MU1/P1 of utility. Thus MU1/P1 measures the worth of last one
rupee spent on product no. 1.

Equality of MU1/P1 & MU2/P2 means that utility of last Re 1 spent on each
good should be equal.

To get into the depth of concept, let us imagine that now the current division of
income between two goods, MU1/P1 > MU2/P2. ie utility that can be obtained
from one extra rupee spent on good no. 1 is more than the same derived from the
last rupee spent on good no. 2. So, if Re 1 is reallocated from good 2 to good 1,
increase in utility from purchase of good 1 will exceed the decrease in utility
from reduction in purchase of good 2. Thus, it is clear that this type of
reallocation increases total utility of the consumer. The reallocation should
continue until MU1/P1 = MU2/P2 (optimum condition ). Once this condition is
reached, no more increase in utility is possible from reallocation of expenditure
from one good to another.

A simple problem is worked out to illustrate the concept:

A consumer spends his income on two goods where prices are Rs. 4 & Rs. 10. At
current level of consumption of two goods, MU1 = 8 & MU2 = 30. Is the
consumer behaving optimally? If not, what changes are recommended to
achieve optimality ?

Solution :
MU1/P1 = 8/4 = 2
 MU2/P2 = 30/10 = 3
So her MU2/P2 > MU1/P1 ( not equal, not in optimum case).
3 – 2 = Re 1; If she spends Re 1 less on good 1, loss of utility is 2 & that Re 1 on
good 2 utility increases by 3. So total utility rises by 1 due to reallocation of
expenditure from product 1 to 2. This reallocation should be continued till
optimum condition MU1/P1 = MU2/P2 is attained.

Thus equi-marginal principle states that input should be allocated in such a way
that the value added by last unit is same in all cases.

Also, Equi-marginal principle holds good only in cases where the law of
Diminishing Return operates.