MARGINAL RATE OF SUBSTITUTION

The amount of a good that a consumer is willing to give up for another good, as long as the new good is equally satisfying. It's used in indifference theory to analyze consumer behavior. The marginal rate of substitution (MRS) is calculated between two goods placed on an indifference curve, displaying a frontier of equal utility for each combination of "good A" and "good B". The marginal rate of substitution is always changing for a given point on the curve, and mathematically represents the slope of the curve at that point. For example, a consumer chooses between hamburgers and hotdogs. In order to determine the marginal rate of substitution, the consumer is asked what combinations of hamburgers and hotdogs provide the same level of satisfaction. When these combinations are graphed, the slope of the resulting line is negative. This means that the consumer faces a diminishing marginal rate of substitution: the more hamburgers they have relative to hotdogs, the fewer hotdogs the consumer is willing to give up for more hamburgers. If the marginal rate of substitution of hamburgers for hot dogs is 2, then the individual would be willing to give up 2 hotdogs in order to obtain 1 extra hamburger.