1.

Explain with the help of a numerical example, the meaning of diminishing marginal rate of substitution

Answer»

Diminishing marginal rate of substitution implies rate at which a consumer is willing to substitute one goods for each additional unit of the other goods tends to decline when the consumer consumes more of that goods. For example, suppose we have the consumption bundles of a consumer as given in the following schedule :

Units of Goods 1Units of Goods 2
110
26
33
41


We also know that MRS is calculated as :

Change in consumption of Goods 2 / Change in consumPtion of Goods 1=∆y/∆x

Now, in the given schedule,

To increase the consumption of Goods 1 by 1 unit, the consumer has to sacrifice 4 units (10 - 6) of Goods 2.

So the Marginal Rate of Substitution when the consumer increases the consumption of Goods 1 from 1 to2 units is, 10-6/2-1=4/1=4

Now, similarly, when the consumer increases the consumption of Goods 1 by one more unit, the consumer has to sacrifice 3 units (6 - 3) of Goods 2.

So, the Marginal Rate of Substitution when the consumer increases the consumption of Goods 1 from 2 to 3 units is, 6-3/3-2=3/1=3

 After this, when consumer increases the consumption of Goods 1 by one more unit, the consumer has to sacrifice 2 units (3 - 1) of Goods 2.

Thus, the Marginal Rate of Substitution when the consumer increases the consumption of Goods  1 from 3 to 4 units is, 3-1/4-3=2/1=2

Hence, we can see that the Marginal Rate of Substitution (MRS) is declining as and when the consumer consumes an additional unit of Goods 1 and we can say that MRS is diminishing in nature.


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