Marginal Replacement Ratio (RMS)

The Marginal Replacement Ratio (RMS) represents the rate at which an individual is willing to exchange one good for another while remaining indifferent. For this reason it is also known as the Marginal Rate of Substitution (TMS).

For example, if the RMS is equal to 3, it means that the individual is willing to give up 3 units of Y to obtain 1 unit of X. The RMS is equal to the quotient between the marginal utility of good X and the marginal utility of good Y with negative sign:

Graphical representation of the Marginal Replacement Ratio (RMS)

The RMS between two goods is the number of units of the good “Y” (the one found on the ordinate axis) that we are willing to give up in exchange for receiving units of the good “X” (abscissa axis), always keeping the consumer utility level.

Graphically, the RMS is the slope of the Indifference Curve at each point, so it will vary depending on the section of the curve in which we calculate it. Therefore, the RMS is always negative and decreasing:

  • It is negative becauseyou have to do without one good to obtain a greater quantity of another good, this occurs because the indifference curve is decreasing.
  • And it is decreasing becausethe consumer the more he has of the good “Y” the more willing he will be to give it up to obtain units of “X” and the less he has of the good the less he will yield.

 

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