In life, you have to choose everything. Go to a dance or gym, put on a skirt or pants (for men, of course, easier), buy yogurt or cottage cheese dessert? All these processes have long been observed by experts in various industries: sociologists, psychologists, marketers, and simply economists.
In microeconomics, there is a theory about the marginal rate of substitution. By definition, this is the number of goods of one type that the buyer agrees to refuse in favor of acquiring another product. Let's talk not so abstractly about this phenomenon.
Why microeconomics?
Translated from Greek, "microeconomics" - these are the laws of farming "small houses". The problems of production, consumption and choice of resources by enterprises of different patterns of ownership and just households are the subject of interest in microeconomics.
This science is theoretical, but it allows us to explain almost all the economic processes taking place in society.
The main areas of interest in microeconomics are:
⢠Consumer problem.
⢠Manufacturer's problem.
⢠Issues of market equilibrium.
⢠The theory of the public good.
⢠Issues of the influence of the external environment.
The concept of âmarginal rate of substitution of goodsâ refers precisely to the sphere of problems of microeconomics and makes it quite easy to answer questions.
Utility theories
The theory of the usefulness of the goods suggests that by buying each unit of a product, the consumer satisfies his needs. So, itâs getting a little happier. The aspirations of all specialists in the world are ultimately aimed at making people happier.
Currently, at the same time there are such theories of utility: cardinalist and ordinalist. The first assumes that the utility from the consumption of goods can literally be calculated. This theory is sometimes called the quantitative theory of utility. Supporters argue that the usefulness of consumption of goods is measured in a conventional unit - scrap.
The second, the ordinal or relative theory of utility, argues that the consumer compares the benefit (utility) of consumption of one product with the same benefit from the consumption of another. Roughly speaking, each time, choosing between a cup of coffee with a bun and a cola with a hamburger, we decide what will bring more benefits at the moment. Within the framework of the relative theory of utility, the marginal rate of substitution appeared.
Definition
Everything in the world is striving for balance. Our selection of products is no exception. When buying one, we consciously refuse the other. At the same time, we are sure that the purchased will bring more benefits than left on the shelf of the store. The marginal rate of substitution of goods gives us an understanding of how some âproductsâ are more important than others. Of course, each of us has our own preferences and priorities. But for the economy, such a subjective idea is not suitable. A generalized approach is needed.
The marginal rate of substitution is equal to the ratio of the change in the quantity of consumed goods. This formula is written as follows: MRS = (y 2 - y 1 ) / (x 2 - x 1 ).
Changing the consumption (use) of goods X and Y allows us to draw conclusions about consumer preferences, as well as talk about the value of the goods. The only factor that can be measured in the theory of product selection is its price. All other characteristics of the product and the reasons for its selection are very subjective. In an attempt to replace one product with another, the consumer seeks to maintain financial costs at the same level. And itâs better to reduce consumption costs.
Indifference curves
Indifference curves clearly show all kinds of sets of benefits that the consumer acquires. At the same time, we make a reservation that the consumer does not care what product to choose. For example, the choice between apples and oranges, city transport or commercial routes. On the axes of the plane, the number of goods being compared is displayed (on the X axis, for example, a cup of tea, and on the Y axis, cookies).
In the end, on the curve we see exactly how many apples the consumer is ready to give up in favor of buying one additional orange. And vice versa. In the case when each monetary unit is equally useful when purchasing the goods to be compared, one speaks of maximizing the utility and rational distribution of the consumerâs budget, i.e., the marginal rate of substitution is reached. Further observations of the consumerâs decision to purchase show that if the cost of 1 apple is less than the cost of 1 orange, the consumer will choose an apple.
General theory of rational consumption
Indifference curves usually reflect equal marginal utility. But we note that in the case when the marginal utility of the product X is twice the price, and the product Y is three times. The consumer will switch to the purchase of goods, even without regard to the fact that it is more expensive.
This will cause a redistribution of the entire budget, because the cost of goods will increase. The marginal utility rate in this case is achieved by the "rationalism effect" of the buyer, who seeks to get the maximum benefit from the purchase of goods.
A rational buyer constantly evaluates the current market situation and redistributes the direction of expenses.
Special cases of marginal utility
The economy distinguishes between the so-called ordinary goods, substitute goods and complementary goods. The first are partially interchangeable goods (water and compote), the second are completely replacing each other (Coca-Cola and Pepsi-Cola), and the third are goods that complement each other (ballpoint pen and rod to it).
For all the cases described, the marginal rate of substitution of goods is a special (exceptional) case. So, if in the general case a curve with a negative slope and convexity towards the beginning of the axes, then for substitutes the graph takes the form of a straight line intersecting the coordinate axes. The slope of this line depends on the price of goods, while the degree of concavity of the curve is determined by the possibility of replacing one product with another.
Factors of production and substitution rate
As in the private sector, economists at enterprises try to track the utility of purchased and consumed resources. In this case, the marginal rate of technological substitution is calculated. Unlike goods in the consumer market, enterprises track changes in one factor of production to increase (decrease) in another. The limitation is the volume of output - it must remain unchanged.
The most common indicator is the marginal rate of substitution of labor by capital. You can invest in production additional funds, not paying attention to changes in labor. But in this case it is said that at a certain point production will decline, because in order to remain on one indifference curve, it is necessary to compensate for the increase in one factor by a decrease in another. This situation is contrary to the production of the
marginal product. Therefore, enterprises have to find a balance between factors of production.
The marginal rate of substitution of production factors is the most important indicator for calculating the economic efficiency of an enterprise.
How are marginal utility and replacement rate related?
Of course, each product is beneficial. Until a certain point, each subsequent unit of goods also brings additional benefits. But at some point this increase in consumption of one thing ceases to be beneficial. Then we talk about achieving the marginal utility of the product.
If we remain on the same indifference curve and move along it in some direction, then we can talk about compensation for the usefulness of goods: a decrease in the consumption of one leads to an increase in the consumption of the other; total utility does not change. Additional utility is considered as marginal utility of each product. The formula is written like this: MRS = Py / Px.
Properties of the marginal rate of substitution
⢠The marginal rate of substitution ratio is the ratio of the marginal utilities of two products.
⢠A negative value of the marginal rate of substitution means that a decrease in consumption of one product automatically causes an increase in the use of another.
⢠The marginal rate of substitution is considered only when moving up and down the indifference curve.
⢠All of the above âworksâ only for general cases (partially interchangeable products); for all particular options, this characteristic is not considered.