Proportionality Rule Or

Consumer's Equilibrium
The proportionality Rule is known by a variety of
names.
The Law of Substitution,
The Law of Maximum satisfaction,
The law of indifference,
The Law of Equi-marginal Utility and
Gosen Second Law.
 Marshal defined it as "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.
Example: Let us assume two commodities X
and Y where the marginal utility of X is better
than Y, then the consumer substitutes X over Y
till it gets equalized.
The consumer will allocate his budget on food,
clothing, recreation and medical care etc.
Since each commodity carry its own value, that
the last dollar spent on each good or service
gives him the same marginal utility.
 If the last dollar spent on commodity X gives him
less marginal utility, he will withdraw this amount
from X and spend it on Y if it gives him higher
marginal utility.
Thus substituting one commodity for another
with a higher marginal utility till marginal utility of
each commodity is in proportion to its price and
the ratio of its prices of all commodities is equal
to the ratio of their marginal utilities.
 This is known as proportionality rule which sets
the situation of consumer's equilibrium in the
case of two commodities as:
MUA / PA = MUB / PB, where MU is the Marginal
Utility of commodity A and B and P is the price.
This is further denoted as MUA / MUB = PA / PB.
A= Apples and B = Bananas
 Suppose the customer is willing to expend $10
on two commodities, whose prices are $4 and
$2 respectively.
Let us substitute with the above equation.
MUA / PA = 40 / 4 = MUB / PB = 20 / 2.
MUA / MUB = PA / PB = 40 / 20 = 2
The consumer's equilibrium can thus be stated
in three ways.
The first condition is when he equalises the
marginal utility of each commodity weighted by
its price :
MUA / PA = MUB / PB.

 The second condition is when he equalises the
ratio of marginal utilities with the ratio of the prices of
all commodities MUA / MUB = PA / PB and
The third condition is that the consumer's must
spent his entire income on the purchase of the
commodities (both Apples and Bananas). This
expressed as:
Y = PA x A + PB x B
When the consumer buys 4 units each of apples
and bananas and spend his entire income of Rs.12.
Thus Rs.12 = (2 x 4) + (1 x 4).
 The Limitations
Imperfect Knowledge It is assumed that the
consumer has a perfect knowledge of the
alternative choices open to him. In reality most
of the consumers are ignorant about other useful
alternatives.
Goods Indivisible money and utilities may be
divided according to the convenience of the
consumer, it is not possible to divide all goods in
small units.
 Choices Uncertain consumers choices are uncertain
and even risky. The expected utilities that determine
consumers choices of the various commodities and he
can buy with a given money income.
Consumer Irrational we buy goods under the impact
of fashion, custom or advertisement. Under the
circumstances, it cannot be expected of the consumer to
act rationally.
No fixed accounting period there is no fixed
accounting period of the consumer in which he can buy
and consume commodities.
Utility not measurable the principle of maximum
satisfaction is based on the unrealistic assumptions of
the cardinal measurement of utility and the constancy of
the marginal utility of money.
 Application of the Law
The law of equi-marginal utility is of great
practical importance.
The application of the principle of substitution
extends over almost every field of economic
enquiry.
Basis of consumer Expenditure - Every
consumer consciously trying to get the maximum
satisfaction from his limited resources acts upon
this principle of substitution.
 Basis for saving and consumption
consumer will try to distribute his limited means
between his present and future uses so as to
have equal marginal utility in each.
In the field of Production the businessman
always applies this principle to maximise his
profits.
In the field of Exchange exchange, barter or
money, is nothing but the principle of substitution
itself.
 For determining Prices it is also applicable in
the determination of prices. A scarce good
carries a high price. In order to bring its price
down.
In Distribution to substitute one factor service
for another till the cost of employing each equals
the marginal revenue resulting from its use.
In Public Finance taxes are levied in such a
manner that the marginal sacrifice of each
taxpayer is equal.