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Equi Marginal Principle

The document discusses the equi-marginal principle and how consumers allocate their income between goods to maximize satisfaction. It states that at the point of equilibrium, the marginal utility per peso spent should be equal between goods. This equilibrium must also satisfy the budget constraint, where total expenditure equals total income. An example is provided to demonstrate how to determine the optimal combination of goods that maximizes utility while meeting the budget constraint.

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robert sabelo
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769 views14 pages

Equi Marginal Principle

The document discusses the equi-marginal principle and how consumers allocate their income between goods to maximize satisfaction. It states that at the point of equilibrium, the marginal utility per peso spent should be equal between goods. This equilibrium must also satisfy the budget constraint, where total expenditure equals total income. An example is provided to demonstrate how to determine the optimal combination of goods that maximizes utility while meeting the budget constraint.

Uploaded by

robert sabelo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Equi-marginal Principle

What is equi-marginal principle?


• The consumer maximizes his satisfaction by allocating his income in
such a way that the marginal utility if the last peso spent on a piece of
hamburger is equal to the marginal utility he gets from the last peso
spent on a bottle of coke. Assuming a two – commodity world where
the consumer can only have goods X and Y, the equi-marginal principle
can be expressed mathematically as:
Formula:
MUx = MUy
PX PY

Where MUx and MUy, represent marginal utility derived from good X
and Y respectively; Px and Py are the given prices of the goods.
Budget Equation
• It is possible that several combinations of goods X and Y will meet the equi-
marginal condition. You have to remember besides the prices of the goods,
an additional constraint is the amount of money that we have in order to
purchase such commodities. Thus, to satisfy the income or budget
constraint (i.e., to make sure that the total expenditures on goods X and Y
would be equal to the total income) the following condition must also be
met:
I=Px.X+Py.Y
• Where I stands for income, Px represents the prices of good X and Y
respectively; X and Y stands for the quantity X and Y bought respectively.
The equation states that the sum of expenditure on good X (Px.X) and the
expenditure on good Y (Py.Y) must equal total income , I.
Example. Marginal utilities per peso worth of Kikiam and barbecue
Quantity (Q) Total Utility from Marginal Utility - MUk/Pk Total Utility (TU) Marginal Utility MUcbbq/
Kikiam (TUk) Kikiam(MUk) from Chicken from Barbeque Pcbbq
Barbeque (cbbq) (cbbq)
1 30 30 15 100 100 10

2 39 9 4.5 155 55 5.5

3 45 6 3 198 43 4.3

4 50 5 2.5 228 30 3

5 54 4 2 248 20 2

6 56 2 2 260 12 1.2

Pk = 2 pesos per stick ; PB = 10 pesos per stick of barbeque; and Income or budget of the consumer = 46 pesos
To get the best combination

1. What combination of K and cbbq will maximize utility?


2. Does this meet the income constraint?
• Following the equimarginal principle, there are two combinations,
namely:
• 3 kikiam + 4 cbbq; and
• 5 kikiam + 5 cbbq
3. To determine the optimum combination, we subject the two
combinations into our budget equation. The combination that fits the
budget equation is the optimum combination.
• I = Px + Py . Y
Choosing the best combination

• First combination: P2 (3) + P10 (4) = P46; which is equal to the budget of
the consumer
• Second combination: P2 (5) + P10 (5) = P60; which is greater than the
budget

• Clearly, the first combination will give the equilibrium of the consumer
or optimum combination because it satisfies both the equi-marginal
principle and the budget constraint. Derivation of the demand schedule
of the consumer for kikiam to derive the demand schedule of the
consumer for kikiam, let as increase the price of kikiam to 3 pesos per
stick and follow the same procedure as above to derive the new
combination.
Deriving demand using equi-marginal principle and Budget
equation
• Following the same steps as we did above we will arrive at a new
combination at kikiam and 4 CBBQ. The demand schedule for kikiam
is therefore:
PRICE (pesos) QUANTITY DEMANDED

2 3

3 2
Indifference Curve Approach

• Another method of explaining consumer behavior is the


indifference curve approach

• This approach is patterned after the utility theory where


the consumer states his preference by just ranking basket of
commodities according to utility received from these
baskets of commodities.
• Consider the following two baskets of goods.
Basket 1 Basket 2
2 bananas 3 bananas
4 guavas 3 guavas

Given the combinations of goods, one can state his


preference as:
I prefer basket 1 to basket 2 or
I prefer basket 2 to basket 1 or
I am indifferent between basket and basket 2
• All the combinations of the two goods, say X and Y , that
the consumer derives the same level of utility comprises
the indifference curve of the consumer.

• A set of indifference curve which represents various level


of satisfaction or utility to the consumers is called
indifference map.

• The indifference curve that lies farther away from the


origin represents a higher level of utility.
3 Assumptions of Preferences:

 Completeness: Preference are assumed to be complete.


Consumers can compare and rank all possible baskets. For
any 2 market baskets A and B, a consumers will prefer A to
B, will prefer B to A or will be indifferent between the two.

 Transitivity: Preference are transitive. Transitivity means


that if consumer prefers basket A to B and basket B to C,
then the consumer also prefer A to C. Transitivity is
normally regarded as necessary for consumer consistency.
 More is better than less: Goods are assumed to be
desirable. Consequently, consumers always prefer more
good to less. In addition, consumers are never satisfied or
satiated; more is always better, even if just a little better.
Marginal rate of substitution
• Is the maximum rate at which the consumer would be willing to
substitute a little more of good X for a little less of good Y.

• It is the increase in good X that the consumer would require in


exchange for a small decrease in good Y in order to leave the
consumer just indifferent between consuming the old or the
new basket.
• It is the rate of exchange between good X and Y that does not
affect the consumer’s welfare.
• It is the negative of the slope of the indifference curve:
MRSxy = Change in good Y/change in good X ( for a constant
level of preference
Budget Line
• The budget line is a locus of points representing combinations
of maximum amounts of goods and services that a consumer
can purchase given his level of income and price of the
commodities

• Also referred to as line of attainable combination


• Determined by the two points:
I /Px ; I/Py where I is the income and is the price

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