Equi marginal utility

Answer 1

Equimarginal utility principle states that to maximise the utility, a rational consumer spends his budget on consuming the amount that gives him the highest marginal utility per dollar for each commodity. For example,

say Tom has a budget of $5. He has two commodities to choose from- a pen and an erazer. Let each commodity cost him the same amount of money- $1.

Now marginal utility for each is:

Number Marginal Utility of pen/dollar Marginal Uitlity of erazer/dollar

1 11 9

2 10 7

3 7 5

4 4 3

According to the principle or law of equi marginal utility, Tom's (a rational consumer) tendancy will be to buy a combination of pen and erazer that will give him maximum satisfaction, until his budget is used up entirely.

In this case, Tom's budget is $5. So, he will tend to buy 3 pens and 2 erazers.

Now, suppose, that the two goods (pen and erzer) don't cost the same amount. Say, the pen costs $2 instead of one. In that case, the combination will be different.

Number Marginal Utility of pen/dollar Marginal Utility of erazer/dollar

1 5 1/2 9

2 5 7

3 3 1/2 5

4 2 3

In this case, Tom will have the combination of 2 pens and 3 erazers.

Mathematically,

the principle is like this:

Marginal utility of A/ price of A = Marginal Utility of B/Price of B

If they are not equal in any case, they should be maximum MU for both goods within the budget line.