ABSTRACT
The consumer will always aim to be on his highest indifference curve. This will be where an indifference curve just touches the consumption feasibility set - such as at A in Figure 2.1. Note how the marginal rate of substitution equals the price ratio (MRS= P). This is necessary if the consumer is actually maximising welfare. (Imagine a position where MRS= 3 and P= 2. How could we raise welfare?)
Production We assume that a country’s stock of factors of production is fixed, but that all can be used in producing either X or Y; we also assume that firms maximise their profits, which implies minimising costs for any level of production. The marginal cost of X is the (minimum) cost of producing an additional unit of X, and similarly for Y. The marginal rate of transformation (MRT) is the rate at which the marginal unit of X can be transformed into Y. This is merely the ratio of their marginal costs. It may also be thought of as the marginal opportunity cost of Y in terms of X - i.e. how much X has to be forgone in order to raise Y-output by one unit.
