Law of Equi-Marginal Utility (Law of Substitution)

This law was originally propounded by H. H. Gossen and later systematically developed by Alfred Marshall. The law states
that in order to get maximum satisfaction, a consumer allocates his income in such a way that the marginal utility of last rupee
spent on each commodity is equal. In other words, the consumer will maximize his satisfaction by consuming up to that level
where the ratio of the marginal utility to price of each good be equal to marginal utility of money. Let us assume that a consumer
consumes only two commodities X and Y and their prices are PX and PY respectively. The utility maximization condition of a
consumer for a commodity X is;
𝑴𝑼𝒙
= 𝑴𝑼𝒎 ………………………..(i)
𝑷𝒙
The utility maximization condition of a consumer for a commodity Y is;
𝑴𝑼𝒚
= 𝑴𝑼𝒎 ………………………..(ii)
𝑷𝒚
The condition required by a consumer to maximize his utility for two commodities X and Y is given as:
𝑴𝑼𝒙 𝑴𝑼𝒚
𝑷𝒙
= 𝑷𝒚 = 𝑴𝑼𝒎…………………(iii) (From equation i and ii)
𝑴𝑼𝒙 𝑴𝑼𝒚
This equation is utility maximization condition of consumer of two commodities X and Y. When 𝑷𝒙
> 𝑷𝒚
, the consumer
substitute commodity X (with higher marginal utility) for commodity Y (with lower marginal utility), that is, he will buy more
of X and buy less of Y. This will lead to fall in MUX and rise in MUY. The consumer will continue to buy more units of X till
𝑴𝑼𝒙 𝑴𝑼𝒚 𝑴𝑼𝒙 𝑴𝑼𝒚
= . When < , the consumer will buy more of Y and less of X. This will lead fall in MUy and rise in MUX.
𝑷𝒙 𝑷𝒚 𝑷𝒙 𝑷𝒚
𝑴𝑼𝒙 𝑴𝑼𝒚
The consumer will continue to buy more of Y till = . Thus, the process of substitution of one commodity for another
𝑷𝒙 𝑷𝒚
so as to maximize consumers’ utility or satisfaction is known as Law of Substitution.
Assumptions of the Law of Equi-Marginal Utility
1. Consumer is rational. He tries to get maximum satisfaction.
2. Utility can be measured in cardinal number
3. Marginal utility of money remains constant. (Whatever the level of consumers’ income, each unit of money has utility equal
to 1).
4. Income of the consumer remains constant.
5. Diminishing marginal utility
Let us suppose that the money income of the consumer is Rs. 18 which he spends on two goods X and Y. Let the per unit price
of X and Y be Rs.2 and Rs 3, respectively. Now the equilibrium position is explained in the following table;

Units MUx MUy 𝑴𝑼𝒙 𝑴𝑼𝒚

𝑷𝒙 𝑷𝒚
1 24 42 12 14
2 20 36 10 12
3 16 30 8 10
4 12 24 6 8
5 8 18 4 6
6 4 12 2 4

The above table shows that the consumer reaches equilibrium when he purchases 3 units of X and 4 units of Y. Here the
marginal utility of both X and Y are equal i.e. 8 utils. The total utility of 3 units of X would be 12+10+8= 30 utils and 4 units
of Y would be 14+12+10+8 = 44 utils which gives total utility equals to 74 (=30+44) utils. This total utility represents
maximum utility derived by the consumer out of his expenditure of Rs. 18. If the consumer spends his income on X and Y in
any other manner, his/her total utility will be less than the maximum. This can be explained with help of figure below:

Y Y
𝑀𝑈𝑥 𝑀𝑈𝑦
𝑃𝑥 𝑃𝑦 14

12 Gain in utility 12 Loss in utility

10 10 P

8 E1 8 E2
L
6 6
4 4
𝑀𝑈𝑥 𝑀𝑈𝑦
2 2 𝑃𝑦
𝑃𝑥
N M Q R
0 1 2 3 4 5 6 X 0 1 2 3 4 5 6 X
Units of X Units of Y
The figure shows that consumer reaches equilibrium by purchasing 3 units of X and 4 units of Y because the marginal utilities
of money spent on these goods are equal(E1N=E2R) to each other. In this situation the consumer gets maximum satisfaction
or utility. Any other combinations will give less total satisfaction. Suppose a consumer buys one unit more of X and
consequently one unit less of Y, this will lead to decrease in total utility. It is evident from the above figure that by purchasing
one unit more of X the gain will be equal to LMNE1 and by purchasing one unit less of Y the loss will be equal to PQRE2.
In this case, the gain in utility(LMNE1) is less than the loss of utility(PQRE2). Thus, only 3 units of X and 4 units of Y is the
equilibrium combination where the marginal utilities derived from the last rupee spent on each commodity are equal.

Derivation of Demand Curve: Cardinal Utility Approach

Prof. Alfred Marshall derived the demand curve with the help of law of diminishing marginal utility. The law of diminishing
marginal utility states that as the consumer purchases more and more units of a commodity, he gets less and less utility from the
successive units of the expenditure. At the same time, as the consumer purchases more and more units of one commodity, then
lesser and lesser amount of money is left with him to buy other goods and services. So it is only at a diminishing price at which
the consumer would like to demand more and more units of a commodity.
For derivation of demand curve, let us take the single commodity (X) case. The demand curve shows the relationship between
price and quantity demanded of a commodity. Under cardinal approach, the equilibrium of the consumer with single commodity
case can be defined as:
MUX = PX
The negative portion of the marginal utility curve does not form part of the demand curve, since negative quantities do not make
sense in economics. The positive segment of MUX curve represents the price demand curve of the consumer which is derived
with the help of figures below,
Y Y
Price
Marginal Utility

E1 J
MU2 P2

E2 K
MU1 P1

DX
0 X1 X2 X 0 X1 X2 X
Quantity MUX Quantity
Fig. ‘A’ Fig. ‘B’
In fig. ‘A’ the MUx is negatively slopped. It shows that as the consumer acquires larger quantities of good x, its marginal utility
diminishes. Consequently, at diminishing price, the quantity demanded of the good x increases as is shown in fig. ‘B’.
At X1 quantity the marginal utility of a good is MU1. This is equal to P1 by definition. The consumer here demands OX1 quantity
of the commodity at P1 price. Similarly, at X2 quantity the marginal utility is MU2, which is equal to P2. At P2, the consumer will
buy OX2 quantity.
This price and equilibrium quantity relationship has been shown in figure ‘B’. The price quantity combination corresponding
equilibrium points, E1 and E2 have been shown to points J and K, respectively. By joining the points J and K, we get the demand
curve for commodity ‘X’. The demand curve, DX, is the usual downward slopping demand curve. It reflects that there is an
inverse relation between price and the quantity demanded of a commodity having negatively slopped demand curve.
Criticisms / Limitations of Cardinal Analysis
1. Consumer’s ignorance: A consumer gets maximum satisfaction if he is rational. In case of ignorance, he cannot judge
among the commodities having higher or lower utility. Hence, lack of proper knowledge, information and ignorant
behavior of the consumer do not help to achieve higher level of satisfaction from their limited resources.
2. Cardinal measurement of utility is not possible: Utility obtained by consuming goods is subjective matter and it cannot
be expressed in terms of cardinal numbers. But it can be measured by rank or ordinal.
3. Marginal Utility of money does not remain constant: The assumption that marginal utility of money remains constant
is unrealistic. In actual life, marginal utility of money differs from one income group to another and one consumer to
another. Marginal utility of money is higher for lower income group and lower for higher income group.
4. Diminishing marginal utility is not valid for all types of goods: There are some exceptional goods do not obey the law
of diminishing marginal utility. The hobby of listening music, earning money drinking wine etc. may also have increasing
 marginal utility.
5. Customs and tradition: Actual expenditure of every consumer is influenced by fashion, customs, and habits. Under
their influence, many of a times the consumer buys more of such goods which give less utility and buys less of those
goods which give more utility. Hence, in this case, the consumer does think about utility.