Marginal Rate of Substitution - Indifference Curve - YouTube

Marginal Rate of Substitution

We have learnt how to derive the IC.

In this session we are going to deal with MRSxy because

the shape of the IC is governed by this..

Well , what do we mean by that?

The Principle of Diminishing Marginal Rate of Substitution of X for Y means

the quantity of Good-Y that the consumer is willing to sacrifice declines

when he tries to get one more additional unit of Good-X.

We can easily understand this principle with the help of our popular graph.

To begin with the consumer has the combination A.

It contains 12 Units of Good-Y and 1 unit of Good-X

He wants to get one additional unit of Good-X.

Only by offering what he has with him, he can get it.

He has 12 units of Good-Y.

He gives away 4 units of it and gets one unit of X

After the exchange, his new combination is B.

It consists of 8 units of Good-Y and 2 units of Good-X.

In the segment AB the MRSxy = 4

The consumer goes for one more unit of Good-X.

Now , he has to offer Good-Y to carry out the exchange.

Since the stock of Good-Y at his disposal decreases.

He is not willing to offer 4 Unit of Good-Y.

He offers only 3 units.

After this exchange, his new combination C contains 5 units of Good-Y and 3 units of Good-X.

In the BC segment of IC the MRSxy = 3 only.

It diminishes from 4 to 3.

The consumer decides to get one more additional unit of Good-X

He is willing to sacrifice only 2 units of Good-Y in order to acquire one additional unit of X.

As the stock of Good-Y keeps on falling with every exchange,

the consumer is very much concerned about the quantity of Y.

Hence his offer in terms of Y also keeps on falling,

In the segment CD the MRSxy = 2

Similarly when he goes for one more unit of Good-X

He is willing to part with just one unit of Good-Y.

The MRSxy in the region DE is just one.

From this what we have to understand is –

As the stock of Good-Y decreases with every exchange activity,

the number of units of Good-Y the consumer is willing to part with diminishes.

Look at the IC again –

As the consumer descends from A to E ,

the MRSxy diminishes as 4,3,2,and 1.

This is popularly known as the Principle of Diminishing Marginal Rate of Substitution.

It is because of this –

IC is convex towards the origin

All the combinations on the same IC yield the same level of satisfaction.

Now the finer Points –

MRSxy is the same as slope of the IC.

Since MRSxy differ at different segments of the IC, slope also differs.

And Slope shows the rate at which the consumer would like to exchange one good for another.

At last a question to the viewers –

Can the rate at which the consumer would like to exchange one good for another differ at different points on the IC?

If your answer is ‘Yes’

I am happy that I have explained the concept well.

Thanks for watching … Meet again…..