Economics – Utility | e-Consult

The equi-marginal principle states that consumers should allocate their income to goods until the marginal utility per pound spent is equal across all goods. In simpler terms, a consumer should spend their last pound on the good that provides them with the greatest additional satisfaction per unit cost.

To illustrate, consider a consumer with income 'I' and utility derived from consuming good X and good Y. The consumer will allocate their income such that:

• MUx/Px = MUy/Py

Where MUx is the marginal utility of good X, Px is the price of good X, MUy is the marginal utility of good Y, and Py is the price of good Y. The consumer will continue to reallocate their income until this condition is met.

Assumptions: The principle relies on several key assumptions:

• Rationality: Consumers are rational and aim to maximize their utility.
• Stable Preferences: Consumers' preferences are relatively stable over the decision period.
• Perfect Information: Consumers have complete and accurate information about prices and marginal utility.

Potential Limitation: A key limitation is that the principle assumes consumers can accurately predict the marginal utility of future consumption. This is often difficult in practice, as marginal utility can be subjective and influenced by factors like satiety or changes in circumstances. Furthermore, the principle doesn't account for external factors like social influences or advertising that might affect consumer choices.