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.
