2.1. Equi-marginal Principle

Question 1

Equimarginal Principle

Answer 1

a consumer will maximise their utility when the marginal utility per unit of money spent (MU / P) on each product is the same.
- Equi-marginal principle derives the demand curve for two or more products, unlike the law of diminishing utility, which derives the demand curve for one product

Question 2

MU (A) / P (A) =

Answer 2

MU (B) / P (B)

Question 3

What happens when the Equi-marginal Principle is achieved?

Answer 3

consumer equilibrium occurs.

Question 4

Consumer Equilibrium

Answer 4

When consumers achieve maximum satisfaction from their income
- Consumer equilibrium occurs when the equi-marginal principle is achieved

Question 5

Equimarginal Principle Explanation

Answer 5

• If MUa/Pa > MUb/Pb then a rational consumer will consume more of a.
• However, as more of a is consumed, MUa falls (due to diminishing marginal utility).
• As MUa falls, MUa/Pa falls until MUa/Pa = MUb/Pb and equi-marginal principle is restored.

Question 6

Marginal rate of substitution of A for B

Answer 6

MUa / MUb = Pa / Pb

Question 7

Marginal rate of substitution of B for A

Answer 7

MUb / MUa = Pb / Pa

Question 8

Law of Demand

Answer 8

a decrease in price leads to an increase in quantity demanded

Question 9

Deriving Demand Curves from Equi-marginal Principle

Answer 9

• Equi-marginal principle occurs when MUa/Pa = MUb/Pb.
• If the price of product a decreases, MUa/Pa rises.
• However, now MUa/Pa > MUb/Pb.
• Therefore a consumer will maximise their utility by consuming more of product a and less of product b until equi-marginal principle is restored.
• This leads to an increase in quantity demanded (extension in demand) for product a.
• Therefore the demand curve for product a is downward sloping.
• Vice versa for a rise in price of product a.

Question 10

Equimarginal Principle Evaluation

Answer 10

• It is difficult to evaluate utility
• Consumers don’t have time to calculate “marginal utility / price”
• Consumers are not always rational
• There are many, many goods to choose from
• Many goods are related
• Often goods can’t be split up into small portions