Why is the MRS = to the price ration?

Solutions

Expert Solution

The Marginal Rate of Substitution (MRS) is defined as the rate at which an individual is willing to sacrifice one good in order to obtain one additional unit of the other good.

The MRS is always equal to the price ratio. Suppose there are two goods: X and Y, The MRS is equal to the price ratio (P_X/P_Y).

If MRS is greater than the price ratio then the consumer would willing to sacrifice more units of good Y in order to obtain an additional unit of good X. The consumer will purchase more units of good X than good Y. This means that the consumer values good X more than the good Y. The consumer will continue to purchase more of good X until MRS becomes equal to the price ratio.

If MRS is less than the price ratio then the consumer would be willing to sacrifice more units of good X in order to gain an additional unit of good Y. The consumer will purchase more units of good Y than good X. This means that the consumer values good Y more than the good X. The consumer will continue to purchase more units of good Y until MRS becomes equal to the price ratio.

So, the final outcome is that the MRS must always equal to the price ratio to attain equilibrium.

Rahul Sunny answered 1 year ago

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