What is the marginal rate of substitution (MRS) and why does it diminish as the consumer substitutes one product for another? Use examples to illustrate.
Marginal Rate of Substitution
As per the definition of Marginal Rate of Substitution, it is the rate at which an individual gives up units of one good in exchange for another. For instance, to have more of good X, a consumer has to give up units of good Y. It suggests that Marginal Rate of Substitution is an economic phenomenon, which explains the preference for a particular good and consumer’s willingness to sacrifice units of one good to have an additional unit of another good. It is very apparent that because of “budget constraint” and “numerous choices’ substitution effects come into play. This substitution has a method, which is explained by the marginal rate of substitution. As per theory, of MRS, the rate of substitution decreases as the exchange increases. For instance, a consumer is willing to give up less of good X in exchange for good Y as the number of exchanges increases. Therefore, the Marginal Rate of Substitution is diminishing, which is rational (Varian, 2014).
From the methodical study of Marginal Rate of Substitution, it is apparent that as the marginal utility for a particular good decrease, so does the willingness of an individual to give up one good for the exchange of another. For instance, for the first slice of pizza, an individual would be willing to give up several pastries, which he/she has in abundance. However, for the second slice of pizza, he/she will not be willing to give up the same units of pastries. As the number of exchanges will increase, the rate of substitution will decrease because the utility derived from every next slice of pizza will be smaller from the previous slice.
Marginal Rate of Substitution affects the economy in a number of ways. In fact, the shared economy has emerged, which is partially based on the concept of the marginal rate of substitution (Marr, 2016).
References
Marr, B. (2016, October 21). The Sharing Economy – What It Is, Examples, And How Big Data, Platforms and Algorithms Fuel It. Retrieved from https://www.forbes.com/sites/bernardmarr/2016/10/21/the-sharing-economy-what-it-is-examples-and-how-big-data-platforms-and-algorithms-fuel/#4da5c86d7c5a
Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. W. W. Norton & Company.
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