Consumer theory based on the marginal rate of substitution function

Abstract

This paper presents an alternative structure of demand theory based on a marginal rate of substitution (MRS) function. The theory's new results include: 1) criteria are derived for goods to be normal/inferior, "ordinary"/Giffen, and substitutes/complements, for the n-goods case; 2) the total effect of a price change is decomposed into MRS and relative price (RP) effects, corresponding respectively to income and substitution effects for an own-price change but not for a cross-price change; 3) the RP effect of a cross-price increase is always positive; and 4) a good is a complement if and only if the MRS effect is negative and its absolute value is larger than the RP effect. Pedagogically, the new approach makes it possible to teach demand theory speedily and effectively because the MRS is a relatively concrete entity, the theory and its results are transparent, and the results of standard utility-based theory are derived far more easily.