Assumption and Importance of the Law of Equi-Marginal Utility

Assumption of the Law:

The law of equi-marginal utility is based on the following assumptions;

• The consumer is a rational economic man who seeks to maximize his total satisfaction.

• Utility is measurable in cardinal terms. 

• The consumer has a given scale of preference for the goods in consideration. He has perfect knowledge of utility derived. 

• Prices of goods are unchanged. 

• Income of the consumer is fixed. 

• Marginal utility of money is constant.

• Wants and goods are substitutable. 

Importance of the Law: 

The law has theoretical as well as practical utility. Theoretically it is a useful device for analyzing the behaviour of a rational consumer. Logically it is a convincing tool to describe the conditions of consumer equilibrium. It opens up analytical areas; it serves as a background for the traditional theory of value. 

The law has the following practical usefulness also: 

1. It Applies to Consumption: 

The law indicates how a consumer derives maximum satisfaction with the help of the principal of substitution; the consumer is able to make the best choice of his wants to gain maximum total satisfaction. It serves as a guide to the consumers to bring about the optimum allocation of his income and expenditure. It thus determines the relative demand for different goods. 

2. It Applies to Production: 

To the producer the law is useful because the very principle of substitution lies in the optimum allocation of resources. The producer can have the most economical or optimal combination of factors of production, when the last unit of investment expenditure brings equal productivity to all the factors of production employed. 

3. It Applies to Exchange: 

This principle has an important bearing on the determination of value. The scarcity of a commodity is reflected through rising prices, in an exchange phenomenon- the market. It, thus, helps in readjustment of resources and adjustment of demand and supply by substitution. 

4. It Applies to Distribution: 

The general theory of distribution involves the principle of substitution. In distributing the rewards of the various agents of production, there shares are determined by the principle of marginal productivity. An optimum distribution is one based on the marginal productivity of factors. This is how the law of substitution is applicable here. 

5. It Applies to Welfare and Public Finance: 

Modern states are welfare states and consider the maximization of social benefits in their revenue and expenditure activities. The principle of ‘maximum social advantage’ involves the law of substitution when it proposes that revenues must be distributed in such a way that the last unit of expenditure brings equal welfare and satisfaction to all classes of people.


Notes provided by Prof. Sujatha Devi B (St. Philomina's College)