Question

Explain the concept of 'Marginal Rate of Substitution' with the help of a numerical example. Also explain its behaviour along an indifference curve.

Answer 1

Bundles	Good$x_1$ (units)	Good$x_2$ (units)
A	5	1
B	2	2
C	1	3

Marginal rate of substitution refers to the rate at which a consumer is willing to substitute one good additional unit for the other. Algebraically, it is represented as follows.

$MRS=\frac{{\Delta }_{x2}}{{\Delta }_{x1}}$

This can be better understood with the help of the following numerical example:

Now,as we can see a movement from bundle A to bundle B, the consumer must sacrifice 3units of good $x_1$ in order to get one more u unit of $x_2$ i.e., $MRS\frac{=}{-3}1=-3$

As we move down along the indifference curve to the right, Marginal Rate of Substitution decreases. This is because as the consumer consumes more and more of one good, the marginal utility of the good falls. On the other hand, the marginal utility of the good which is sacrificed rises. In other words, the consumer is willing to sacrifice less and less for each additional unit of the good consumed. Thus, as we move down the is, MRS diminishes. the suggests the convex shape of the indifference curve.

For instance, in the example given above, a movement further from bundle B to C suggests that with of increase in good 2, the consumer's willingness to sacrifice good 1 falls to 1 unit. Thus, MRS falls.