Marginal rate of substitution - what is it? Marginal rate of substitution of labor by capital

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:43

In life, everything has to be chosen. Go to a dance or the gym, put on a skirt or trousers (it is certainly easier for men), buy yogurt or cottage cheese dessert? All these processes have long been observed by specialists from various industries: sociologists, psychologists, marketers and just economists.

In microeconomics, there is a theory about the marginal rate of substitution. By definition, this is the quantity of goods of one type that the buyer will agree to give up in favor of purchasing another product. Let's talk not so abstractly about this phenomenon.

Why microeconomics?

Translated from the Greek "microeconomics" - these are the laws of housekeeping "small houses". The problems of production, consumption and choice of resources by enterprises of different forms of ownership and just households are the subject of interest of microeconomics.

This science is theoretical, but it allows us to explain almost all economic processes taking place in society.

Main areas of interestmicroeconomics are called:

• The problem of the consumer.

• The problem of the producer.

• Issues of market equilibrium.

• Public good theory.

• Issues of external influence environment.

The concept of "marginal rate of substitution of goods" refers precisely to the sphere of problems of microeconomics and allows you to quite simply answer the questions that arise.

Utility theories

The theory of the utility of a product says that by buying each unit of a product, the consumer satisfies his needs. And that means you get a little happier. The aspirations of all professionals in the world are ultimately aimed at making people happier.

Currently, there are simultaneously such theories of utility: cardinal and ordinal. The first assumes that the utility of consuming a product can literally be calculated. This theory is sometimes called the quantity utility theory. Proponents argue that the usefulness of consuming a product is measured in a conventional unit - waste.

The second, ordinalist, or relative theory of utility, states that the consumer compares the benefit (utility) of consuming one good with the same benefit from consuming another. Roughly speaking, every time we choose between a cup of coffee with a bun or a Coke with a hamburger, we decide which will bring more benefit at the moment. Within the framework of the relative theory of utility, the marginal rate of substitution appeared.

Definition

Everything in the world strives for balance. Our selection of products isexception. Buying one thing, we deliberately refuse another. At the same time, we are sure that what is bought will bring more benefits than what is left on the store shelf. The marginal rate of substitution of goods gives us an understanding of how much some "products" are more important than others. Of course, each of us has our own preferences and priorities. But such a subjective representation is not suitable for economics. A generalized approach is needed.

The marginal rate of substitution is equal to the ratio of the change in the quantity of goods consumed. The formula is written as follows: MRS=(y₂ - y₁) / (x₂ - 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 product choice theory is its price. All other characteristics of the product and the reasons for choosing it are very subjective. In an attempt to replace one product with another, the consumer seeks to keep the financial costs at the same level. Better yet, reduce consumption spending as well.

Indifference curves

Indifference curves clearly show all kinds of sets of goods that the consumer acquires. At the same time, we make a reservation that the consumer does not care which product to choose. For example, the choice between apples and oranges, public transport or commercial routes. The axes of the plane show the number of goods being compared (on the x-axis, for example, cups of tea, and on the y-axis, cookies).

At the end of the curve, we see exactly how many apples the consumer is willing to give up in favor of buying one extra orange. And vice versa. In the case when each monetary unit is equally useful when buying compared goods, one speaks of utility maximization and rational distribution of the consumer's budget, i.e., the marginal rate of substitution has been reached. Further observation of the consumer's purchasing decision processes show that if the cost of 1 apple is less than the cost of 1 orange, the consumer will choose the apple.

General Theory of Rational Consumption

Indifference curves usually reflect equal marginal utility. But note that in the case when the marginal utility of product X is twice the price, and product Y is three times. The consumer will switch to the purchase of product Y even without regard to the fact that it is more expensive.

This will cause a redistribution of the entire budget, as the cost of good Y will increase. The marginal rate of utility 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 situation in the market and redistributes the direction of spending.

Special cases of marginal utility

In the economy, there are so-called ordinary goods, substitute goods and complement goods. The first are partially interchangeable goods (water and compote), the second are completely replacing each other (Coca-Cola and"Pepsi-Cola") and others - products that complement each other (ballpoint pen and refill).

For all the described cases, the marginal rate of substitution of goods is a special (exceptional) case. So, if in the general case the curve has a negative slope and convexity towards the origin of the axes, then for substitutes the graph takes the form of a straight line crossing the coordinate axes. The slope of this straight line depends on the prices of goods, while the degree of concavity of the curve is determined by the possibility of substituting one product for another.

Factors of production and rate of substitution

As in the private economy, in enterprises, economists try to track the usefulness 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 for an increase (decrease) in another. The limit is the volume of output - it must remain unchanged.

The most common indicator is the marginal rate of substitution of labor by capital. It is possible to invest additional funds in production, not paying attention to changes in labor. But in this case it is said that at a certain moment there will be a decrease in production, since in order to remain on one indifference curve, it is necessary to compensate for an increase in one factor by a decrease in another. This situation is contrary to the productionmarginal product. Therefore, enterprises have to find a balance between the 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 the rate of substitution related?

Of course, every product is useful. Up to 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 are talking about achieving the marginal utility of the product.

If you stay on the same indifference curve and move along it in some direction, then you can talk about compensation for the utility of goods: a decrease in the consumption of one leads to an increase in the consumption of another; total utility does not change. Additional utility is considered as the marginal utilities of each good. The formula is written as follows: MRS=Py/Px.

Properties of marginal rate of substitution

• The marginal rate of substitution is the ratio of the marginal utilities of two goods.

• A negative marginal rate of substitution means that a decrease in consumption of one good automatically causes an increase in the use of another.

• The marginal rate of substitution is only considered when moving up and down the indifference curve.

• All of the above "works" only for general cases (partially interchangeable products); forall private options, this characteristic is not considered.