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Question
Explain the concept of 'Marginal Rate of Substitution' with the help of a numerical example. Also, explain its behaviour along an indifference curve
Solution
Marginal Rate of Substitution means the rate at which the consumer is willing to substitute one commodity for the other commodity.
The optimum bundle of the consumer is located at the point where the budget line is tangent to an indifference curve. When the budget line is tangent to an indifference curve at a point, the absolute value of the slope of the indifference curve and of the budget line is equal at that point, an i.e. marginal rate of substitution (MRS) is equal to the price ratio. The slope of the budget line is the rate at which the consumer is able to substitute one good for the other in the market. At the optimum, the two rates should be the same. Thus, at a point at which MRS is greater, the price ratio cannot be optimum, as well as when MRS is less, the price ratio cannot be the optimum.
MRT = `"ΔY"/"ΔX"` = `"Amount of goody sacrificed"/"Amount of good x gained"`
For example, assuming that resources and technology remain constant, an economy is producing Good X and Good Y. Different combinations of production of Good X and Good Y are given in the product possibility schedule:
| Production Possibilities | Good X | Good Y | MRT = "ΔY"/"ΔX" |
| 1 | 0 | 30 | - |
| 2 | 1 | 27 | -3 |
| 3 | 2 | 21 | -6 |
| 4 | 3 | 12 | -9 |
| 5 | 4 | 0 | -12 |
In the beginning, at the production point II, where 1 unit of Good X and 27 units of Good Y are produced. To produce an additional unit of Good X, 3 units of Good Y must be sacrificed
Here, the marginal rate of transformation (MRT) is
MRT = "ΔY"/"ΔX" = "Amount of good Y sacrificed"/"Amount of good X gained" = `(27 - 30)/(2- 1) = -3`
Thus, MRT or the opportunity cost of getting an additional unit of Good X is 3 units of Good Y.
RELATED QUESTIONS
consumer consumes only two goods X and Y. The Marginal Rate of Substitution is 1. Prices of X and Y are Rs 3 and Rs 4 per unit respectively. Is the consumer in equilibrium? What will be further reaction of the consumer? Give reason.
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