Jim Whitney Economics 250

Wednesday, March 27, 2013

 

The relationship between MRT and MC

MRT =
  • marginal rate of transformation
  • rate at which Y must be sacrificed to get another X
  • the size of the slope of the PPF
  • the opportunity cost of X (in terms of the Y given up)
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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.