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The concept of marginal rate substitution (MRS) was introduced by Dr. J.R. Hicks and Prof. R.G.D. Allen to take the place of the concept of diminishing marginal utility. Allen and Hicks are of the opinion that it is unnecessary to measure the utility of a commodity. The necessity is to study the behavior of the consumer as to how he prefers one commodity to another and maintains the same level of satisfaction.
For example, there are two goods X and Y which are not perfect substitute of each other. The consumer is prepared to exchange goods X for Y. How many units of Y should be given for one unit of X to the consumer so that his level of satisfaction remains the same?
The rate or ratio at which goods X and Y are to be exchanged is known as the marginal rate of substitution (MRS). In the words of Hicks:
“The marginal rate of substitution of X for Y measures the number of units of Y that must be scarified for unit of X gained so as to maintain a constant level of satisfaction”.
Marginal rate of substitution (MRS) can also be defined as:
“The ratio of exchange between small units of two commodities, which are equally valued or preferred by a consumer”.
Importance of Marginal Rate of Substitution (MRS):
(i) Measures utility ordinally: The concept of MRS is superior to that of utility concept because it is more realistic and scientific than the theory of utility. It does not measure the utility of a commodity in isolation without reference to other commodities but takes into consideration the combination of related goods to which a consumer is interested to purchase.
(ii) A relative concept: The concept of marginal rate of substitution has the advantage that it is relative and not absolute like the utility concept given by Marshall. It is free from any assumptions concerning the possibility of a quantitative measurement of utility
Law of Diminishing Marginal Utility
Law of Diminishing Marginal Utility states that marginal utility from consuming each additional unit of a commodity declines as its consumption increases, while keeping consumption of other commodities constant.
MU becomes zero at a level when TU remains constant.