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:
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.