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Trade-Offs and the Marginal Rate of Substitution

Picking up from our last article (linked in the navigation below) on indifference curves and trade offs, here we introduce the marginal rate of substitution.

Marginal Rate of Substitution (MRS): The rate of substitution of good 2 (two) associated with a marginal reduction in quantity of good 1 at bundle B. Take a look at the graph for more insight.

MRS (X1, X2) is the absolute value of the slope of the indifference curve (IC) at that point.

With a change in X1 (downwards) the individual is worse off, so they must be compensated by an increase in good 2 (in an effort to remain indifferent). Seen in formula form:

Diminishing MRS

One is willing to sacrifice less of x2 for x1, the more X1 someone has. So depicted below, MRS decreases as we move down an indifference curve.

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