|Combinations Good X Y
| 1 20 1 –
2 15 2 1:5
3 11 3 1:4
4 8 4 1:3
5 6 5 1:2
6 5 6 1:1
In order to get the second X the consumer is willing to part with 5X(20-15=5) for the third X he is prepared to give up 4Y (15-11=4). For the fourth X he is willing to surrender only 3Y. In other words as he gets more and more of X he is willing to giving up fewer and fewer Y for each extra X. The significance of X in terms of Y goes on diminishing with each addition to his stock of the farmer commodity. As the stock of X increases, every additional X becomes to him less important in terms of Y. This is why he is willing to offer fewer and fewer Y for every extra X. This is referred to as the Principle of Diminishing Marginal Rate of Substitution.
The principle of Diminishing Marginal Substitution is represented in Fig. Since each unit increase in X causes Y to diminish less and less, the numerical value of the slope also goes in declining. In graphic terms, the Law of Diminishing MRS means that the slope of indifference curve must always be decreasing as we mace along it from left to right. This is shown in the Fig. The steps of the staircase are of equal width but of diminishing height from top to bottom. The various points on the curve move to the right by equal distances but they move down by progressively smaller distances. This is due to the fact that while the number of x in the indifferences schedule continues at the rate of one x in various combinations the number of y continues to decline at a progressively diminishing rate. The curve i.e. thus represents the principle of diminishing MRS.
Some economists think that the Hicksian principle of diminishing marginal substitution is only a translation of the conventional principle of diminishing marginal utility. The substitution of one commodity for another is based on marginal utility or marginal significance. The marginal rate of substitution diminishing just as marginal utility diminishes. It is therefore, contended that the principle of the diminishing marginal rate of substitution is in essence similar to the law of diminishing marginal rate of substitution. The points of difference between the two are:
Prof. Hicks has pointed out the dissimilarities between the principles of diminishing Marginal Utility and Diminishing Marginal rate of substitution. The points of difference between the two are:
- The Utility analysis assumes that utility of money is constant. A consumer is prepared to pay lower price for an additional unit of commodity because of the lower utility of the additional unit and not because the utility of money has risen. The assumption of constant utility unit and not because of the lower utility of the money has risen. The assumption of constant utility of money is very unrealistic because it actually increases when the consumer has less income. The indifference curve analysis does not make this assumption.
- They conventional utility analysis is based on the assumption of measurability of utility and on the cardinal number system. The indifference curve analysis believes that utility cannot be added or subtracted. We can only say that satisfaction is better than or inferior to another but we do not say how much. Thus is the ordinal number system of utility.
- The conventional analysis is in terms of only one commodity but the indifference analysis is in terms of two or more goods.
Therefore, the principle of Diminishing Marginal rate of substitution is not the same as the principle of diminishing marginal utility. It is different form and vastly superior to the latter principle.
Reasons for diminishing Marginal Rate of Substitution
- Two goods X and Y are assumed to be imperfect substitutes.
- The increase in quantity of one good does not increase the one satisfying capacity of another good.
- The want for a particular commodity is suitable.