The Equi-Marginal Principle Can Be Applied To Both Consumption As Well As Production. Discuss This Statement With The Help Of An Example?


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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.

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