Scarcity of goods : This law ignores the fact that goods and services are scarce in supply. The law of diminishing marginal returns is also known as the law of diminishing returns, the principle of diminishing marginal productivity, and the law of variable proportions. Wants are unlimited but the income which is available to the consumers to satisfy all his wants is limited. The following are the main exception. In real life we see that all these variables go under change. In such a situation satisfaction cannot be maximised. In other words, 5 units of commodity X and 3 units of commodity Y leave him with the same amount of marginal utility.
The law of equi-marginal utility is also known as the law of substitution or the law of maximum satisfaction or the principle of proportionality between prices and marginal utility. Every person must try to spend his income in a manner which yields him the greatest satisfaction. The law tells us to use substitute commodity, which is less scarce. Marginal utility is the incremental increase in utility that results from consumption of one additional unit. As a result of this substitution the marginal utility of goods Y will rise. Of the things that he decides to buy he must buy just the right quantity. But in actual practice all consumers are not rational.
It is clear that consumer can get maximum utility from the expenditure of his limited income. It is also described as the Law Of economy of expenditure as it analyses the expenditure behavior of the consumer whose aim is to save his money. This means the marginal utility of the fifth good tends to be lower than the marginal utility of the first good. The result is that the price of commodity comes down. Boulding, indefinite budget period is another difficulty in the law. The producer has limited resources.
Production : The law of equi-marginal utility can be extended to production. A consumer attains equilibrium when he gets maximum satisfaction from his expenditure on different commodities. Because of this reason, the law of equi-marginal utility is further referred to as the law of maximum satisfaction, the principle of income allocation, the law of economy in expenditure or the law of substitution. But is is not completely correct. Even though the money and utilities divisible, it is not possible to divide all goods in small quantities. Suppose there are only two goods X and Y on which a consumer has to spend a given income. The law is called the law of substitution.
Since the law of diminishing marginal utility applies to money also, the greater his money expenditure the consumer will go on purchasing goods till the marginal utility of expenditure on each good becomes equal to the marginal utility of money to him. Explanation With Schedule and Diagram: The law of substitution can be explained with the help of an example. There is no need to change the direction of expenditure from one item to another when there are gifts of nature. Free Goods : This law is not applicable in the case of free goods. In other words, when marginal utilities of one commodity divided by its price and the marginal utility of the other commodity divided by its price are equal. Consumers handle the law of diminishing marginal utility by consuming numerous quantities of numerous goods.
Limitations of the Law of Equi-Marginal Utility: The law of equi-marginal utility has been criticised on various grounds. Unrealistic one: The law of equi marginal utility is based on the unrealistic assumption of the cardinal measurement of utility and constancy of marginal utility of money. It Applies to Public Finance The principle of 'Maximum Social Advantage' as enunciated by Professors Hicks and Dalton states that, the revenue should be distributed in such a way that the last unit of expenditure on various programmes brings equal welfare, so that social welfare is maximised. The individual is so full from the first four slices that consuming the last slice of pizza results in negative utility. Consumers have less amount of money when they purchase more and more units of commodities. Therefore, consumer will be in equilibrium when he is buying 5 units of good X and 3 units of goods Y and will be spending Rs.
If marginal utility of money spent on the good A is greater than the marginal utility of money spent on the good B, the consumer will withdraw some money from the purchase of D and will spend it on A till the marginal utility of money in the two cases becomes equal: Any arrangement of expenditure. This is applicable when a consumer buys only cup cake. He, while purchasing commodities, compares. Suppose the prices of the goods are given for the consumer. Limitations of the Law The law of equi-marginal utility bristles with the following difficulties. The law has an important bearing in the determination of value on the basis of their relative scarcity.
But that is not really so. He will substitute that commodity which has more utility in place of less marginal utility and he continues up to that point where the marginal utility from all goods is equalised. The third slice, as before, holds even less utility as the individual is now not hungry anymore. As the marginal utility of oranges is higher, we should buy more of oranges and less of apples. This law states that in order to get maximum satisfaction, a consumer should spend his limited income on different commodities in such a way that the last dollar spent on each commodity yield him equal marginal utility. The law does not imply that the additional unit decreases total production, which is known as ; however, this is commonly the result.