5.10 : Marginal Rate of Substitution

Increased income through additional workdays and fewer holidays can allow a person to afford a larger apartment with more bedrooms. For instance, Nancy, by choosing to work more and reduce her holiday time, can achieve this upgrade in her living space. The indifference curve, or IC, graphically represents these preferences, illustrating the trade-off between the desire for a larger apartment with more bedrooms and the number of holidays she can enjoy.

The marginal rate of substitution is always negative because it reflects the quantity of one good that is sacrificed to gain a quantity of another good under a fixed budget.

Initially, Nancy gives up six holidays for a larger apartment with one additional bedroom.

As she continues trading off holidays for a larger apartment with two additional bedrooms, her willingness to give up even more holidays decreases. This is because as she has fewer holidays, each remaining holiday has more value to her.

For example, when moving from Point D to Point E, she trades one holiday for a larger apartment with one more additional bedroom. So, her MRS decreases, giving the indifference curve its convex shape.