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MARGINAL RATE OF SUBSTITUTION (MRS)
The opinion was there that it was essential to measure the utility of any commodity that is in use. This would help to show how and how much this product is being used by the people. It shows the preferences of the consumers at many times. It shows how a commodity is preferred over the others that are available in the market, which give them all the same level of satisfaction.
There are a number of examples that can be quoted. Let us consider one here. Let us assume two goods X and Y. Let us say that they are not perfect substitutes for each other. The consumer is made to exchange goods in this case. Now our main concern arises when we come to know how much of X he is ready to exchange with how much of Y, with the same level of satisfaction. This rate at which the goods are being exchanged is called as the Marginal rate of substitution.
MRSxy = ?Y
It is very important to note that it is not the market exchange rate, but it is only the personal exchange rate.
Importance of Marginal Rate of Substitution (MRS):
It helps in measuring the utility in ordinals. It is better than the concept of utility as it is more elastic than the utility concept. It is also realistic and it is scientific in nature. The best part about it is that it does not account for the products separately, but takes into consideration the other related goods too that would affect the preferences of the consumers.
It is a relative concept. It is not an absolute one. It does not have any kind of assumptions that are made. These avoid the possible measurements that we are not interested in.
Diminishing Marginal Rate of Substitution:
It is very important to know this concept. From this let us assume the following table to get a better picture.
Combination Good X Good Y-MRS of X for Y
1 1 13 --
2 2 9 4: 1
3 3 6 3: 1
4 4 4 2: 1
5 5 3 1: 1
It shows the five combinations of goods that a person can take. It shows the quantity of the good that he would get in each case. The rates that are shown are the ones that depict how much one good is preferred over the other. The constant change in the ratio shows the diminishing marginal rate of substitution.