Law of EquiMarginal UtilityLaw of EquiMarginal Utility

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BALAJI KANNANBALAJI KANNAN

Law of Equi Marginal UtilityMaximum 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.

Illustration:-Suppose a man goes to the market with Rs.400 in his pocket, which is want to spend on oranges, grapes and Banana, and further. Suppose that the utility he expects to derive from each unit of Rs.25 spent on these commodities is follows.

The Equi Marginal Principle

The optimum amount of two alternatives consumed (or produced)will be where the marginal benefit ratios of the two alternatives are equal to their marginal cost ratios :

MBa MCa ----------- = -------------- MBb MCb

To see the sense of this,say that the last unit of Apple you consumed gave three times as much utility as the last unit of Orange.Yet Apple only cost twice as much as Orange.

Thus ,a consumer gain by increasing the consumption of Apple thereby reducing orange.At one point of time the same consumer start shifting to consume orange since he gained maximum satisfaction in consuming Apple(Applying Law of DMU)

Now the MU of apple falls and results in increase of MU of Orange.This subsitution process continues till MU of Apple = MU of Orange also with the same price.

Rs25/unitUtility derived from the Rs.25 spent on

Oranges Grapes Banana

1St 10 13 11

2nd 8 12 9

3rd 7 10 6

4rth 5 8 5

5th 4 6 4

6th 3 4 2

7th 2 3 1

The purchaser will spend the first 25 on the object, which will give him the greatest satisfaction. In this case such an article is Grapes, the utility of its first unit is 13, which is maximum.

Guided by the same motive, he will spend the second Rs. 25 on Grapes. He will spend the third Rs. 25 on Banana and the forth-on oranges. In this way he will go spending money. The following table indicates the order in which he will spend the Rs.400 he has got with him.

Rs.25 Object of expenditure Utility derived

1St Grapes 13

2nd Grapes 12

3rd Banana 11

4rth Orange 10

5th Grapes 10

6th Banana 9

7th Orange 3

8th Grapes 8

9th Orange 7

10th Grapes 6

11th Banana 6

12th Orange 5

13th Banana 5

14th Orange 4

15th Grapes 4

16th Banana 4

Total utility derived from Rs. 400 out off 117Total utility derived from Rs. 400 out off 117

The above table shows that he will spend Rs. 25 each 5 on The above table shows that he will spend Rs. 25 each 5 on oranges, 6 on Grapes, and 5 on Banana , and will in total oranges, 6 on Grapes, and 5 on Banana , and will in total derive 117 units of utility. This is the maximum satisfaction derive 117 units of utility. This is the maximum satisfaction that he can obtain out of his expenditure. If he does not that he can obtain out of his expenditure. If he does not follow this scheme of expenditure, he will not be able to follow this scheme of expenditure, he will not be able to derive maximum total utility.derive maximum total utility.

Therefore, if we want to derive maximum satisfaction out of Therefore, if we want to derive maximum satisfaction out of our expenditure, we should spend our money in such a way our expenditure, we should spend our money in such a way as to derive, more or less, the same satisfaction from the as to derive, more or less, the same satisfaction from the last unit of money spends on each head. This is the law of last unit of money spends on each head. This is the law of Equimarginal utility.Equimarginal utility.

Some DefinitionsSome Definitions

Total Utility:The total satisfaction a consumer gets from

the consumption of all units of a good consumed within a given time period

Marginal Utility:The extra satisfaction gained from consuming

one extra unit of a good within a time period

Util:An imaginary unit of satisfaction derived from

the consumption fo a good

Law of Diminishing Marginal UtilityLaw of Diminishing Marginal Utility Principal of Diminishing

Marginal Utility:

The more of a product a person consumes ,the less will be the additional utility gained from one more unit.

Or

As more units of a good are consumed,additional units will provide less additional satisfaction than previous units.

MU from consuming biscuits

Biscuit Packets

Consumed

TU in Utils

MU in utils

0 0 -

1 7 7

2 11 4

3 13 2

4 14 1

5 14 0

6 13 -1

Using Calculus to derive the MU Function

A consumer’s typical utility function for a good might be of the form:

TU=60Q-4Q²Where Q is the quantity of the goods

consumedTabulate by constructing a table for TUMarginal Utility is the first derivative of total

utility dTUMU= ----------- =60 -8Q dQ

Problem for Practice

Derive the MU function from the following TU function:

TU = 200Q-25Q²+Q³From this MU Function ,draw up a

table upto the level of Q where MU becomes negative .Graph these figures.

Marginal Consumer Surplus(MCS)

It is the difference between what you are willing to pay for one more unit of a good and what you are actually charged .

For Eg If A is prepared to pay Rs 25 for a Biscuit packet which actually costs him Rs 20,then Rs 5 will be called as Marginal Consumer Surplus(MCS)

Total Consumer Surplus(TCS)

It is the difference between the total utility from all the units and your expenditure on them.

TCS = TU - TE

Marginal Utility and the demand curve of the good

The price elasticity of demand will reflect the rate at which MU diminishes.

If there are close substitutes for a good,it is likely to have an elastic demand,and its MU will diminish slowly as consumption increases.

It is likely that the MU of money diminishes as income rises.

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