Marginal Rate of Substitution

Published Jan 2, 2023

Definition of Marginal Rate of Substitution

The marginal rate of substitution (MRS) is a measure of the rate at which a consumer is willing to substitute one good for another in order to maintain a given level of satisfaction. That means it describes how much of one good a consumer is willing to give up in order to get one additional unit of another good.

Example

To illustrate this, let’s look at an example. Imagine that you are at a restaurant with a bunch of your friends and you have to choose between two side dishes: onion rings and fries. You want to make sure everyone is happy, so you have to decide how many plates of each side dish you should order. Now, let’s assume that you and your friends really like onion rings. So much so that you are willing to give up two orders of fries to get one additional plate of onion rings. In this case, your MRS is 2:1.

Similarly, if some of your friends prefer fries, you might want to order a few more of those. If we assume that the group is willing to give up one order of onion rings to get an additional order of fries, the MRS is 1:1.

Why Marginal Rate of Substitution Matters

The marginal rate of substitution is an important concept in economics because it helps us to understand how consumers make decisions. It is also closely related to the concept of utility, which is a measure of satisfaction or happiness. That means the MRS helps us to understand how much of one good a consumer is willing to give up in order to get one additional unit of another good. This, in turn, helps us to understand how consumers allocate their resources in order to maximize their perceived utility.