Question

Suppose you’re writing a report for state legislators on the economic situation facing consumers. The state legislators would like the following questions answered so that they can better understand consumer behavior and the impact of potential policies on the state economy.

What does the Diminishing Marginal Rate of Substitution mean, and what are the implications of a Diminishing Marginal Rate of Substitution for consumer indifference curves?

Answer 1

The Indifference Curve is the curve which shows the combination of two goods which gives the consumer same level of satisfaction.

Now, the slope of indifference curve is called marginal rate of substitution. This marginal rate of substitution tends to decline as we move along the IC towards the x-axis.

Now, marginal rate of substitution shows us the rate at which consumer is willing to give up one good in order to consume more of the other good. MRS tends to diminish in accordance with the law of diminishing marginal utility. For every additional unit of X, consumer is willing to give uo lesser and lesser units of Y. Due to this, MRS tends to diminish.

The implication of diminishing MRS on IC curve is that IC becomes convex to the origin. If the consumer were instead willing to give up same level of Y commodity, or if MRS were constant, then the IC would be a straight line.