Wednesday, March 27, 2013 |
The relationship between MRT and MC
MRT | = |
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Example: | ||
Suppose the opportunity cost of another X = 2 units of Y | ||
=> | slope of PPF = 2 | |
=> | DY/DX = 2 | |
=> | MCx must = 2.MCy | |
=> | MCx/MCy = 2 | |
=> | Size of slope of PPF = DY/DX = MRT = MCx/MCy = relative cost of X | |
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For example, if MCx=$20 and MCy=$10, then you have free up $20 of resources to get another X, and you have to stop producing 2Y to get the $20 of resources you need. |
Proof:
Consider increasing X by switching labor from Y to X:
DY = MPLy.DL
DX = MPLx.DL
So:
DY ---- DX |
= | MPLy.DL ---------- MPLx.DL |
= | MPLy ------- MPLx |
= | 1/MPLx -------- 1/MPLy |
= | PL/MPLx ---------- PL/MPLy |
= | MCx ----- MCy |
Note:
(1) The numerator tells you how much money you need to produce another
X (MCx).
(2) The denominator tells you the rate you raise money by cutting
production of Y (MCy per Y).
(3) So the ratio tells you how much Y you need to cut in order to
produce another X.