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navneet.casspir Group Title

Why Marginal Rate of Substitution must to equal the ratio of price of 2 given goods for the consumer to achieve maximum satisfaction?

  • 2 years ago
  • 2 years ago

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  1. seanleephoto Group Title
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    If your rate of substitution is different from your ratio of prices, then the relative benefits from the goods is different from the relative costs.

    • 2 years ago
  2. shivamamity Group Title
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    Suppose the consumer had chosen a bundle at which his MRS was higher than the market price ratio. This means that he is willing to give up more units of c2 for a little more c1 than the market requires him to – so he should use the markets to trade some of his c2 for c1 because he would be made unambiguously better off! Now suppose he has traded himself in this way all the way to the point where his MRS equals the price ratio. Should he trade yet more units of c2 to obtain a little more c1 ? The answer is no, because doing so would now mean having to give up more units of c2 than he willing to for a little more c1. Thus, once he has traded his way to the bundle at which his MRS equals the price ratio, he can do no better – he has arrived at his optimal consumption choice, the one that maximizes u(c1, c2) subject to his budget constraint.

    • 2 years ago
  3. waruim Group Title
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    The MRS describes the rate at which the consumer is willing to trade one good for another to maintain the same level of satisfaction. The ratio of prices describes the trade-off that the market is willing to make between the same two goods. The tangency of the indifference curve with the budget line represents the point at which the trade-offs are equal and consumer satisfaction is maximized. If the MRS between two goods is not equal to the ratio of prices, then the consumer could trade one good for another at market prices to obtain higher levels of satisfaction.

    • one year ago
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