Equimarginal Principle in Economics

The Equimarginal Principle in Economics (Managerial Economics) states that different courses of action should be pursued upto the point where all the courses give equal marginal benefit per unit of cost. It claims that a rational decision-maker would certainly allocate or hire resources in a fashion that the ratio of marginal returns and marginal costs of various uses of a provided resource or of various resources in a given use is the same.

Economist H. H. Gossen posited the two basic laws of utility, the Equimarginal Principle and the Law of Diminishing marginal returns. Gossen’s corresponding law of utility maximization says: If a person is free to select between various pleasures but has not time to afford all of them to their full level, then to be able to optimize the sum of his pleasures he or she must engage in all of them to at least some degree before experiencing the largest one fully, in order that the level of each pleasure is the same at the moment when it is stopped; and this however different the absolute level of the several pleasures may be.

This principle is applicable to situations where a limited resource for example time, capital or labor needs to be allocated among more than one independent uses. Taken along with the Law of Diminishing Marginal Returns, it isn’t difficult to see that an optimum solution should indicate that the marginal returns for each of the feasible allocations are equivalent. Without a doubt, if they were not, an improved allocation could possibly be attained by redistributing a unit of resource from a use with smaller marginal returns to one with larger.

Formula: Equimarginal Principle in Economics

For instance, a consumer looking for optimum utility (satisfaction) from his consumption basket, will allocate his consumption budget on services and products such that

MU₁/MC₁ = MU₂/ MC₂ = ………. = MU_n/ MC_n
Where MU1 = marginal utility from good one
MC1 = marginal cost of good one and so on.

In the same manner, a manufacturer in search of maximum profit would use the technique of production (input-mix.) which will ensure
MRP₁/MC₁ = MRP₂/MC₂=…….. =MRP_n/MC_n

You can easily observe that if the above equation is not satisfied, the decision makers could increase his utility/profit by shuffling the resources/input e.g. if MU₁/MC₁>MU₂/MC₂ the customer would certainly add to his utility by purchasing more of item one and less of item two.

Equi-marginal Principle Assumptions

• Utility could be calculated in cardinal numbers.
• Consumer is rational. He desires maximum satisfaction from income. He is influenced by fashion and habits.
• The income of purchaser is steady.
• The prices of products stay constant.
• A good can be split up in small portion. It means that the purchaser can spend his income as he wishes.
• The customer has understanding of the utility offered by different products.
• Utility which a purchaser receives from a product is determined by the quantity of that product only. It’s not at all influenced by the utility resulting from other items.
• Consumption is made at a certain period of time. This implies that the budget period of the purchaser is constant.

Video on Equimarginal Principle and Law of Diminishing Utility

This article has discussed about the Equimarginal Principle in Economics (managerial economics), its formula and assumptions. In real life, usually the equi-marginalism concept needs to be substituted with equi-incrementalism. The reason being, variations in reality are discrete which means the idea of marginal change may not apply at all times. Rather, changes will likely be small in character, but the decision rule or optimising principle will continue to be the same.