How to calculate marginal rate of substitution

Written by james collins | 13/05/2017
How to calculate marginal rate of substitution
Use the MRS to determine how consumers respond to product changes. (Jupiterimages/Comstock/Getty Images)

Also referred to as MRS, the marginal rate of substitution is a rate that tells the analyst how much someone may give up one unit of an asset in exchange for another unit of an asset, considering all other things, including efficiency, held equal. Economists also use the rate as an estimate for how fast a consumer of a particular product will substitute that product for another product. In general, the higher the rate, the higher the indifference customers have for a particular brand name.

Review the formula to calculate MRS. The formula is -dy ÷ dx, where d is the change in the good or service and x and y are the different goods and service. The assumption is that utility remains constant.

Identify the cost of good A and the cost of good B. Assume the cost of good A is £3, and the cost of good B is £6.

Calculate the output of the good or service. For instance, in this example assume product A is a battery that offers you five hours of life and product B is a battery that offers you 12 hours of sleep.

Figure out the marginal rate of substitution. Subtract the change in cost and divide by the change in energy life. In this example, £6 minus £3 is £3, and 12 minus 5 is 7. The MRS is 7/5.

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