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When consumers make choices about the quantity of goods and services to
consume, it is presumed that their objective is to maximize total
utility. In maximizing total utility, the consumer faces a number
of constraints, the most important of which are the consumer's income and
the prices of the goods and services that the consumer wishes to consume.
The consumer's effort to maximize total utility, subject to these
constraints, is referred to as the consumer's problem. The solution to the
consumer's problem, which entails decisions about how much the consumer
will consume of a number of goods and services, is referred to as consumer
equilibrium.
Concept
A consumer is said to be in equilibrium when he feels that he “cannot
change his condition either by earning more or by spending more or by
changing the quantities of thing he buys”. A rational consumer will
purchase a commodity up to the point where price of the commodity is equal
to the marginal utility obtained from the thing.
If this condition is not fulfilled the consumer will either purchase more
or less. If he purchases more, MU will go on falling and a situation will
develop where price paid will exceed MU. In order to avoid negative
utility, i.e., dissatisfaction, he will reduce consumption and MU will go
on increasing till P = MU.
On the other hand, if MU is greater than the price paid, the consumer will
enjoy surplus satisfaction from the units he has already consumed. This
will induce him to buy more and more units of the commodity leading to
successive fall in MU till it is equated to its price. Thus, by a process
of trial and error — by buying more or less units, a consumer will ultimately
settle at the point where P = MU. Here, his is total utility is maximum.
However, P = MU is a necessary but not a sufficient condition for a
consumer’s equilibrium. In Fig. 4, we find that the MU curve is
intersecting the price curve PP at two different points M and N. So far M
is concerned, although by having OA quantity the consumer is reaching the
point where P – MU but it is not equilibrium.
Certainly he would not expect that the last egg he is buying brings him
exactly the same marginal utility as the last cake he is buying. One cake
costs much more than an egg. One may guess that he should go on buying a
good which costs twice as much per unit as another until he ends up in his
equilibrium bringing him just twice as much in marginal utility.
Thus, if the consumer has arranged his consumption so that every single
good brings him marginal utility just exactly proportional to its price,
then he could not gain extra utility and thus improve his position by
departing from such an equilibrium.
Why does this law hold? If any one good gave more marginal utility per
rupee the consumer would gain by taking money away from other goods and
spending more on that good — up to the point where the law of diminishing
marginal utility brought its marginal utility per rupee down to equality.
If any good gave less marginal utility per rupee than the common level, the
consumer would buy less of it’s until the marginal utility of the last
rupee spent on it had risen back to the common level.
Beyond this point, further substitution will not be beneficial to him, for
that would involve a decrease in his total utility. This is known as the
Law of Equi-marginal Utility. Marshall puts the Law in the following
words: “If a person has a thing which he can put to several uses, he will
distribute it between these uses in such a way that it has the same
marginal utility in all”. If he has a greater utility in one use than in
another, he would gain by taking away some of it from the second use and
applying it to the first.
Proof of the Law:
The Law of Equi-marginal Utility can be proved as follows- Let us suppose
that a person has Rs. 5 to spend on X and Y commodities during a particular
period of time, say a day, and he gets marginal utility from each of these
two commodities as shown in the following table:
The table shows that a person can either spend all the five rupees on X or
Y or divide these between the two. If he spends all the five rupees on X,
the last rupee spent on X would give 10 units utility, but if that rupee is
spent on Y (i.e., four rupees for X and one rupee for Y) he will get a
greater amount of utility. So, he will substitute Y for X.
This process continues till the marginal utility of the last rupee spent on
X and on Y will give him the same marginal utility, and he will attain this
stage when he spends Rs. 3 on X and Rs. 2 on Y. At this stage, his total
utility from his spending will become (25 + 20 + 16 = 61 units from X and
21 + 16 = 37 units from Y) 98 units and this will be the maximum amount of
total utility that he can get from his spending. Thus, if a person
equalises the marginal utility from each of his purchases, he gets the
maximum amount of satisfaction. So, the doctrine of maximum satisfaction
can be deduced from this law.
Consumer’s Equilibrium:
This law can also be explained in another way to show the optimum purchase
of the consumer or the consumer’s equilibrium. A consumer buys a commodity
up to that amount at which its price is equal to its marginal utility. In
the case of purchase of many commodities, maximum satisfaction requires the
allocation of income in such a way that the marginal utilities of units of
various goods bought are proportional to their prices.
In other words, if apples cost twice as much per kg. as potatoes, the
consumer must adjust his purchases of these two goods until the marginal
utility of a kg. of apple is twice as great as the marginal utility of a
kg. of potatoes. So, in equilibrium, the marginal utilities of the
different commodities purchased are proportional to their prices and these
ratios of marginal utility to price must be equal to the common marginal
utility of money.
Limitations:
The principle of substitution and the law of equi-marginal utility have the
following limitations:
(i) Too much rationality:
The law of equi-marginal utility assumes too much rationality in the
behaviour of a consumer. In real life, consumers do not always make their
purchases considering minutely the relative marginal utilities of the
different commodities; they make their purchases very often out of fancy or
emotion or social needs without judging carefully their marginal utilities.
In such cases the law does not hold.
Unrealistic Assumptions
This is one of the most common criticisms against theories of social
sciences. The theory of marginal utility is also subject to this criticism.
According to critics, too many unrealistic assumptions haunts over
Marshall’s utility theory. Because of these unrealistic assumptions, the
theory becomes too vague. Critics confront the following assumptions of the
theory:
2. Utility is measurable
Cardinal utility theory claims that utility is measurable in cardinal
numbers (1, 2, 3,….). However, utility is a subjective phenomenon, which
can be felt by a consumer psychologically, and cannot be measured .
4. Rationality
The theory assumes that the consumer is rational. However, various factors
such as advertisement and ignorance can influence the consumer’s decision.