B.7 Marginal rate of transformation Production - Microeconomics_plain.txt

The marginal rate of transformation can be defined as how many units of good X have to stop being produced in order to produce an extra unit of good Y, while keeping the use of production factors and the technology being used constant. It can be determined using the following formula. Nevertheless,...

The marginal rate of transformation can be defined as how many units of good X have to stop being produced in order to produce an extra unit of good Y, while keeping the use of production factors and the technology being used constant. It can be determined using the following formula. Nevertheless, for simplicity’s sake, it is common to note this formula in its absolute value form. It is equal to the derivative of output Y with respect to X. It basically tells us how much the production of output Y will increase or decrease with every additional unit of output X. The following graph represents how much of two goods a firm can produce. The horizontal axis represents the production level of good X, while the vertical axis represents the production of good Y. The curve represents the production possibility frontier. Any point that lies either inside or on it represents a feasible production bundle. Points outside the production possibility frontier are the production possibilities frontier are therefore not feasible. For example, at this specific point of the production possibility frontier, the firm produces 40 units of good X and 100 of good Y. As the point lies just at the production possibility frontier curve, it represents that all input resources are being used and production is at its maximum. The firm may decide to move along the production possibility frontier, and while using the same amount of total inputs, produce a different bundle of goods. This way. way, the firm may increase its production of good X up to 100 units while reducing its production of good Y down to 50 units. The slope of the curves shows how a reallocation of the production can end with a different bundle of production while employing the same quantity of inputs. An increasing marginal rate of transformation will mean an increasing opportunity cost of producing the extra unit of a good. As we can see, as we go down through the slope, more units of good Y have to be given up in order to increase the production of good X. However, not all production possibility frontiers have the same shape. For example, this curve represents a production possibility frontier with a constant marginal rate of transformation and therefore a constant opportunity cost. The same units will have to be given up of one good in order to produce more units of the other good. This second graph portrays the case of perfect substitute X. The slope has an angle of 45° with each axis and therefore we have a marginal rate of transformation equal to 1. The production possibility frontier can also be like this curve. As we can see, this is the opposite shape of our first example. Now we have the case of decreasing marginal rate of transformation and hence a decreasing opportunity cost. The cost in terms of the given up good decreases with every unit we give up in order to produce another unit of the other good. The marginal rate of transformation can help us understand how firms decide how much of each good to produce, depending on input costs or market demand. It’s important not to confuse the marginal rate of transformation with the marginal rate of substitution or the marginal rate technical substitution.