Law’s of Diminishing Marginal Utility

and Equi-Marginal Utility.

By: Malik Abrar AltafLecturer Management Dr. SM Iqbal Business School

Units Total Utility Marginal Utility

1 20 20

2 38 18

3 53 15

4 64 11

5 70 6

6 70 0

7 62 -8

8 46 -16

Example: Law of Diminishing Marginal Utility.

1 2 3 4 5 6 7 8

-20

-15

-10

-5

0

5

10

15

20

25

2018

1511

6

0-8

-16

Marginal Utility

Marginal Utility

1 2 3 4 5 6 7 8

-40

-20

0

20

40

60

80

Total Utility & Marginal Utility.

Total UtilityMarginal Utility

Units: Quanitity Consumed

Un

its

of

uti

lity

Important points to remember

• Total Utility goes on increasing at a diminishing rate and then goes on decreasing at a diminishing rate ,when the marginal utility becomes zero.

• Total utility of a quantity of a commodity is maximum, when the Marginal utility is zero.

• Marginal utility goes on increasing with every diminution of the stock.

• Marginal Utility = Change in total utility/Change in quantity consumed.

Why does Marginal utility fall when the quantity of commodity with the consumer

increases.1. Each Particular Want is satiable.

When a consumer consumes more & more of a commodity , his wants is satisfied and he does not desire further increments of the commodity. Thus his Marginal utility decreases as consumption increases and a stage will come when it becomes zero , and after that will become negative ( Disutility).

2. Goods are imperfect substitutes for one another.

Different commodities satisfy different wants . When a consumer goes on consuming a commodity , the marginal utility falls as his want is satisfied , but if the commodity could be substituted for other commodities , it would have satisfied other wants and hence its marginal utility would have increased, even though its quantity increases.

Limitations of the Law.

• Suitable Units. • Suitable Time.• No change in Consumer’s Tastes. (Craving)

• Normal Persons.• Constant income.• Rare Collections. ( Ancient Coin Collection)

• Change in other People’s Stock.( Land & Railway)

• Other Possessions.(Carriage without horse)

• Fashion.• Not Applicable to Money.

Law of Equi-Marginal utility

More Urgent Less Urgent

Wants

Balance

MU of Other Commoditie

s

MU of Particular

Commodity

1 2 PriorityPriority

Resources Limited

Unlimited

Competition

Money

1. Simply an Extension of Law of Diminishing Marginal Utility to two or more commodity purchase.

2. Also Called as :Law of Maximum Satisfaction.Law of substitution.Law of Economy of Expenditure.Law of Indifference.Law of Proportionate rule.Gossen’s Second Law.

Statement:Maximum satisfaction out of the expenditure of a given sum can be obtained if the utility derived from the last unit of money spent on each object of expenditure is, more or less the same.

Introduction

Suppose a person has Rs.5 with him which he wishes to spend on two commodities, Tea and cigarettes. The marginal utility derived from both these commodities is as under:

Example:

Units of Money MU of Tea MU of Cigarettes1 10 122 8 103 6 84 4 65 2 3

Rs.5 Total Utility = 30 Total Utility = 39

A rational consumer would like to get maximum satisfaction from Rs. 5.00. He can spend this money in three ways. (1)    Rs. 5.00 may be spent on tea only(2)    Rs. 5.00 may be utilized for the purchase of cigarettes only.(3)    Some rupees may be spent on the purchase of tea and some on the purchase of cigarettes. If the prudent consumer spends Rs. 5.00 on the purchase of tea, he gets 30 utility. If he spends Rs. 5.00 on the purchase of cigarettes, the total utility derived is 39 which is higher than tea. In order to make the best of the limited resources, he adjusts his expenditure. (1)    By spending Rs. 4.00 on tea and Rs. 1.00 on cigarettes, he gets 40 utility (10+8+6+4+12=40).(2)    By spending Rs. 3.00 oa tea and Rs. 2.00 on cigarettes, he derives 46 Utility (10+8+6+12+10=46).(3)    By spending Rs. 2.00 on tea and Rs. 3.00 on cigarettes, he gets 48 utility (10+8+12+10+8=48).(4)    By spending Rs. 1.00 on tea and Rs. 4.00 on cigarettes, he gets 46 utility (10+12+10+8+6=46). The sensible consumer will spend Rs. 2.00 on tea and Rs. 3.00 on cigarettes and will get the maximum satisfaction. When he spends Rs. 2.00 on tea and Rs. 3.00 on cigarettes, the marginal utility derived from both these commodities is equal to 8. When the marginal utilities of the two commodities are equalized, the total utility is then maximum i.e., 48 as is clear from the schedule given above.

 (i)     Effect of 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 know 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 to Choose.

If there is no perfect freedom between various alternatives, the operation of law may be impeded.

Limitations of the Law

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