Answer to Question #59266 in Microeconomics for Bob

Question

Explain what we mean by Marginal Rate of Substitution (MRS). Using this concept, explain why market basket A, which is not tangent to the budget line, is not utility maximizing, while market basket B, which runs tangent to the budget line, is utility maximizing

Answer 1

Marginal Rate of Substitution (MRS) is the amount of a good that a consumer is willing to give up for another good, as long as the new good is equally satisfying. Using the concept of MRS, market basket A, which is not tangent to the budget line, is not utility maximizing, because either not all the budget is spent on consumption or there is not enough budget to afford such level of consumption, while market basket B, which runs tangent to the budget line, is utility maximizing, because all the budget is efficiently spent on consumption of goods from the basket.