Equi-marginal principle The equi-marginal principle was originally associated with consumption theory and the law is called 'the law of equi-marginal utility'. The law of equi-marginal utility states that a utility maximizing consumer distributes his consumption expenditure between various goods and services he/she consumes in such a way that the marginal utility derived from each unit of expenditure on various goods and services is the same. The pattern of consumer's expenditure maximizes a consumer's total utility. The law of equi-marginal principle has been applied to the allocation of resources between their alternative uses with a view to maximizing profit in case a firm carries out more than one business activity. This principle suggests that available resources (inputs) should be so allocated between the alternative options that the marginal productivity gain (MP) from the various activities are equalized. For example, suppose a firm has a total capital of Rs. 100 million which it has the option of spending on three projects, A, B, and C. Each of these projects requires a unit expenditure of Rs. 10 million. Suppose also that the marginal productivity schedule of each unit of expenditure on the three projects is given as shown in the following table. Units of Expenditure Marginal Productivity (MP) (Rs. 10 million) Project A Project B Project C 1st 501 403 354 2nd 452 305 306 3rd 357 208 209 4th 2010 10 15 5th 10 0 12 Going by the equi-marginal principle, the firm will allocate its total resource (Rs. 100 million) among the projects A, B and C in such a way that marginal product of each project is the same i.e., MpA = MPB = MPC. It can be seen from the above table that going, by this rule, the firm will spend 1st, 2nd, 7th, and 10th unit of finance on project A, 3rd, 5th, and 8th unit on Project B, and 4th, 6th, and 9th unit on project C. In all, it puts 4 units of its finances in project A, 3 units each in projects n and C. In other words, of the total finances of Rs. 100 million, a profit maximization firm would invest rs. 40 million in project A, Rs. 30 million each in projects B and C. This pattern of investment maximizes the form's productivity gains. No other pattern will ensure this objective. The equi-marginal principle suggests that a profit maximizing firms allocates MpA = MPB = MPC = … = MPN If cost of project (COP) varies from project to project, then resources are so allocated that MP per unit of COP is the same. That is, resources are are allocated in such proportions that The equi-marginal principle can be applied only where (i) firms have limited investible resources, (ii) resources have alternative uses, and (iii) the investment in various alternative uses is subject to diminishing marginal productivity or returns.
