Marginal Rate of Substitution
- Marginal Rate of Substitution
- The rate at which an individual must give up “good A” in order to obtain one more unit of “good B”, while keeping their overall utility (satisfaction) constant. The marginal rate of substitution is calculated between two goods placed on an indifference curve, which displays a frontier of equal utility for each combination of “good A” and “good B”.
As such, the marginal rate of substitution is always changing for a given point on the indifference curve, and mathematically represents the slope of the curve at that point.
For example, consider an indifference curve between hamburgers and hot dogs at a picnic. If the marginal rate of substitution of hamburgers for hot dogs is 2, then the individual would be willing to give up 2 hamburgers in order to obtain 1 extra hot dog.
The Law of Diminishing Marginal Rates of Substitution states that MRS decreases as one moves down on the standard convex-shaped curve, which is the indifference curve. The marginal rate of substitution is another way of mathematically expressing the opportunity cost for one more unit of something; in this case the opportunity cost is the giving up of some other specific good.
Investment dictionary.
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2012.
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