What is the Marginal Rate of Substitution?

The marginal rate of substitution is the rate at which it is necessary to forgo consumption of one product in order to secure an additional unit of a different product and still receive the same level of satisfaction overall. From this perspective, this type of rate can be viewed as a compromise or a trade-off that makes it possible for the consume to still meet needs or wants in an acceptable manner, even if the exact means of obtaining that satisfaction has changed. Companies as well as individuals make use of this particular economic strategy on a daily basis as they seek to maximize the return on the amount of income they have available to spend.

The key to understanding the marginal rate of substitution is to acknowledge that there is more than one way to satisfy needs and wants. The decision of which way to use at a given point in time will vary. This means that substituting one product for one or more units of another product may be desirable in a particular time and setting, while a different means of managing the substitution will provide more satisfaction at a different time.

One of the easiest ways to understand how the marginal rate of substitution works is to consider making a purchase at a fast food restaurant. The consumer has only so much money to spend for the meal, and must determine which combination of selections will provide the most satisfaction. On the one hand, choosing a daily special that includes a hamburger, French fries, and a beverage would probably satisfy the hunger. At the same time, the consumer may decide that choosing several items off the discounted menu would also calm the hunger, and make it possible to enjoy a wider selection of tastes during the meal.

By giving up or substituting the budget chicken tenders, a small beverage, an small order of onion rings, a small hamburger, and a small salad for the daily special, the consumer gives up the pleasure of eating the super-sized hamburger and larger order of fries. At the same time, he or she gains the benefit of enjoying a more varied meal, without spending any more money.

Another example of employing the marginal rate of substitution in the same setting would be making a decision between purchasing hamburgers or hot dogs. Assuming that two hot dogs cost the same as one hamburger, the consumer may determine that giving up that one hamburger in order to enjoy two hot dogs is an acceptable substitution. In either case, satisfaction is derived, although the decision to go with the two hot dogs may provide a little more satisfaction in terms of making it possible to consume more food without spending any more money.

Companies often use the marginal rate of substitution when purchasing materials and supplies for a business operation. By making wise choices, they may find it is possible to order a specified amount of a given supply product and receive another product that is also considered desirable at no cost. By giving up the purchase of the other brand, the company is able to not only enjoy the benefits obtained from the similar product, but also obtain a little more satisfaction from the acquisition of another desirable item.