Question

what is the marginal rate of substitution, and what role does it play in determining the consumer’s optimum choice?

Answer 1

Marginal rate of substitution is the rate of substitute in one good for the other. In consumer optimisation problem, there is an indifference curve that is tangent to a budget constraint. The indifference curve represents the utility of the consumer and the budget constraint represents the resource constraint with which the given consumption bundle can be purchased.

Marginal rate of substitution is the slope of this indifference curve and at the optimal bundle, it should be equal to the slope of the budget constraint. When this happens the resultant bundle provides the maximum satisfaction given the resources available. Due to this reason the role of marginal rate of substitution becomes pivotal. In case the marginal rate of substitution is greater than the slope of the budget constraint, the consumer is required to change its consumption bundle by consuming more of the good measured on the horizontal axis and reducing the consumption of the good measured on the vertical axis. The opposite is the valid when the marginal rate of substitution is less than the slope of a budget constraint.