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Pastimes : Austrian Economics, a lens on everyday reality
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To: gpowell who wrote (275)11/11/2003 7:57:37 PM
From: gpowell  Read Replies (2) of 445
 
Marginal rate of substitution

Let’s assume for the moment a two good system. A multiple choice system can be reduced to a two choice system by the creation of a composite good that represents all goods save one.

The marginal rate of substitution is the combination of good changes that just leave the decision maker indifferent to the change, i.e. how much does good 1 need to change in relation to a change in good 2 to make the consumer indifferent to the two states. This necessary change in good 1, given a change in good 2, that just maintain the decision maker’s indifference defines the marginal rate of substitution of good 1 for good 2.

An interesting observation is that, in equilibrium and under rational utility maximizing assumptions, all market participants have the same marginal rate of substitution for every good they choose to consume.
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