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Unformatted text preview: s of goods 181 and MRTS which is measured in terms of factors. Instead we must equate MRS = MRT which are both measured in terms of goods. So let's investigate the logic behind the overall efficiency requirement that MRS = MRT... This requirement means that the consumption allocations must be compatible with the production allocations. MRS (marginal rate of substitution) specifies the amount of one good, say good Y, which can be substituted for another good, say good X, along the same indifference curve. For example, MRS = 1 means that to reduce one unit of good X, the consumer requires 1 additional unit of good Y in order to be on the same indifference curve. MRT (marginal rate of transformation) specifies the amount of one good, say good Y, which can be substituted for another good, say X, along the same PPF. For example, MRT = 2 means that to reduce one unit of X, the economy has the resources to produce 2 more units of good Y and is still on the same PPF. The consumer is thus better off since the consumer requires only 1 additional unit of good Y and yet the economy can produce 2 additional units of good Y. In other words, the allocation associated with MRS MRT is NOT Pareto Optimal. 182 THE PRODUCTION SIDE OF THE MODEL First we solve the equations that make up the production side efficiencies: KX + KY = K LX + LY = L MRTSX = MRTSY (= MRTS) (1) (2) (3) These solutions will give us all of the Pareto Optimal allocations (KX, KY, LX, LY) of factors. Next, we substitute these factor allocations into the production functions... X = f(KX, LX) Y = g(KY, LY) (7) (8) and we obtain all possible corresponding output levels X and Y. That is, we first derive the factor contact curve and then construct the corresponding PPF. In other words, the production possibility frontier represents the information captured in the optimal solutions of the five equations (1), (2), (3), (7), and (8) relating to the productions side of the economy. Y PPF X So this is the same PPF you heard about in your introductory economi...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10