Economics, 3rd Edition

MRS =

P

x

P

y

Because the marginal rate of substitution equals the ratio of marginal utilities, we can write this condi-

tion for optimization as:

MU

x

MU

y

=

P

x

P

y

---

CHAPTER 5  BACKGROUND TO DEMAND: THE THEORY OF CONSUMER CHOICE  115

Now rearrange this expression to become:

MU

x

P

x

=

MU

y

P

y

This equation has a simple interpretation: at the optimum, the marginal utility per euro spent on good 

x  

equals the marginal utility per euro spent on good 

y. At any other point, the consumer is not in equilib-

rium. Why? As we saw above, this is because the consumer could increase utility by changing behaviour, 

switching spending from the good that provided lower marginal utility per euro and more on the good that 

provided higher marginal utility per euro.

At the consumer’s optimum, the consumer’s valuation of the two goods (as measured by the marginal 

rate of substitution) equals the market’s valuation (as measured by the relative price). As a result of this 

consumer optimization, market prices of different goods reflect the value that consumers place on those 

goods.