According to this principle, different courses of action should be pursued up to the point where all the courses provide equal marginal benefit per unit of cost. It states that a rational decision-maker would allocate or hire his resources in such a way that the ratio of marginal returns and marginal costs of various uses of a given resource or of various resources in a given use is the same. For example, a consumer seeking maximum utility (satisfaction) from his consumption basket, will allocate his consumption budget on goods and services such that
MU1/MC1 = MU2 / MC2 =……..= MUn / MCn,
Where MU1 = marginal utility from good one, MC1 = marginal cost of good one and so on.
Similarly, a producer seeking maximum profit would use the technique of production (input-mix.) which would ensure
MRP1/MC1= MRP2/MC2= ………… =MRPn/MCn
MRP1/MC1 = MRP2/MC2 =………….=MRP/ MC Where MRP1=Marginal revenue product of input one (e.g. Labour), MC1= Marginal cost of input one and so on.
It is easy to see that if the above equation was not satisfied, the decision makers could add to his utility/profit by reshuffling his resources/input e.g. if MU1/ MC1>MU2/MC2 the consumer would add to his utility by buying more of good one and less of good two. Table 2.2 summarises this principle for different sellers.
Example: A multi-commodity consumer wishes to purchase successive units of A, B and C. Each unit costs the same and the consumer is determined to have a combination including all the three items. His budget constraint is such that he cannot buy more than six units in all. Again, he is subject to diminishing marginal utility i.e. as he has more of an item, he wants to consume less of it. Table 2.3 shows the optimisation example:
The utility maximising consumer will end up with a purchase of 3A+2B+1C because that combination satisfies equimarginalism:
In the real world, often the equi-marginalism concept has to be replaced by equi- in-crementalism. This is because, changes in the real world are discrete or lumpy and therefore the concept of marginal change may not always apply. Instead, changes will be incremental in nature, but the decision rule or optimising principle will remain the same.