Consumer Equilibrium and the Law of Equi-Marginal Utility :: Business Economics

Consumer Equilibrium and the Law of Equi-Marginal UtilityIntroductionThe 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 matures and services. This law states that how a consumer allocates his money income between various goods so as to obtain maximum satisfaction.AssumptionsThe principle of equi-marginal utility is establish 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 galore(postnominal) buyers in the guts 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 cost of units or utils. This utility is not only comparable but also quantifiable.PrincipleSuppose 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 yThe consumer is in equilibrium position when marginal utility of money expenditure on separately 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 whenMUx =MUyWhere MU is Marginal Utility and P equals Price Px PyIf MUx / Px and MUy / Py are not equal and MUx / Px is greater than MUy / Py, then(prenominal) 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.TableLet us illustrate the law of Equi-Marginal Utility with the help of a tableThe side table shows marginal utilities of goods x and y.