B.Com. LL.B. (Five Years) Sem 1 Micro Economics 2021 Oct Question Paper with Solutions

For full marks, cover: the problem the law solves; its statement (Gossen 1854, Marshall's words); the assumptions; a worked schedule with unequal prices; the equilibrium condition MUx/Px = MUy/Py = MUm; the diagram; the uses; the limitations; and a conclusion.

The problem

Wants are many and income is limited. A consumer must decide how to divide his income among different goods. The law of equi-marginal utility tells him how to divide it so as to get the maximum total satisfaction.

It is also called the law of substitution and the law of maximum satisfaction. H.H. Gossen first stated it in 1854, so it is known as Gossen's second law.

Statement

Alfred Marshall put it this way in Principles of Economics (eighth edition, 1920): "If a person has a thing which he can put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all."

Sita spends each rupee where it gives the highest utility per rupee. She buys the first unit of X first, because it gives 12 utils per rupee. Next she buys the second unit of X and the first unit of Y, which give 10 each. She goes on in the same way.

With Rs 11 she buys 4 units of X (Rs 8) and 3 units of Y (Rs 3). At this point:

• MUx / Px = 12 / 2 = 6
• MUy / Py = 6 / 1 = 6

The two ratios are equal, so Sita is in equilibrium. Her total utility is 72 from X plus 24 from Y, which is 96 utils.

Check. If she bought 5 of X and 1 of Y (also Rs 11), she would get 80 plus 10, which is 90 utils. If she bought 3 of X and 5 of Y, she would get 60 plus 30, which is again 90. So the equal-ratio point gives the most.

3. Public finance. The government divides its budget among different heads to give the greatest social benefit.
4. Saving. A person divides income between spending now and saving for the future in the same way.

Limitations

1. Utility cannot be measured exactly in numbers.
2. Consumers act from habit and custom, not careful calculation.
3. Goods are often indivisible, so exact equality is not possible.
4. The marginal utility of money changes as money is spent.
5. Consumers lack full information about the satisfaction goods will give.

Conclusion. The law of equi-marginal utility says how a consumer gets maximum satisfaction from a limited income. He divides it so that the marginal utility of the last rupee spent on each good is equal: MUx/Px = MUy/Py. In Sita's case, 4 units of X and 3 of Y give 96 utils, more than any other choice costing Rs 11. The law rests on the measurement of utility, which is its weakness. But its principle of balancing at the margin guides choices in consumption, production and public spending.