Theory of Law of Substitution

Law of Substitution

The law of substitution is also known as the law of equi-marginal utility or the law of maximum satisfaction. This law was first developed by H.H Gossen. Therefore, this law is also known as second law of Gossen. Prof. Marshall has developed and given the present shape of this law.

According to this law, if a consumer is to use all the available resource in the consumption of a single commodity then marginal utility,derived from every additional unit will decrease successively. This law states that in order to get maximum satisfaction, a consumer should spend his limited income on different commodities in such a way that the last dollar spent on each commodity yield him equal marginal utility.

Explanation of the Law:

In order to get maximum satisfaction out of the funds we have, we carefully weigh the satisfaction obtained from each rupee ‘had we spend If we find that a rupee spent in one direction has greater utility than in another, we shall go on spending money on the former commodity, till the satisfaction derived from the last rupee spent in the two cases is equal.

The law of substitution  is also known as ” The Law Of Maximum Satisfaction” because the consumer can maximize his/her satisfaction by spending income in accordance with this law. It is called ” The Law Of Substitution” because the consumer will go on substituting one commodity with higher marginal utility for another commodity with lower marginal utility till the marginal utility of each commodity is equal. Suppose, there are two commodities X and Y on which a consumer has to spend a given income. If he finds that the marginal utility of commodity X is higher than the marginal utility of commodity Y, he will substitute the former for the latter till their marginal utilities are equalized.

Assumptions of Law of Equi-Marginal Utility:
The main assumptions of the law of equi-marginal utility are as under.
(i) Independent utilities. The marginal utilities of different commodities are independent of each other and diminish with more and more purchases.
(ii) Constant marginal utility of money. The marginal utility of money remains constant to the consumer as he spends more and more of it on the purchase of goods.
(iii) Utility is cardinally measurable.
(iv) Every consumer is rational in the purchase of goods.
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