There absolutely are options to use them…
Both of these option are enabled by default, i.e. they’re On unless you change them.
If you have an upgrade that wants the lower materials, the blacksmith will use the higher materials instead, at a 1:1 ratio, e.g. if your upgrade wants 20 lower level scraps you can use 20 higher level scraps instead.
If you have an upgrade that wants the higher materials, the blacksmith will use the lower materials instead, at a 20:1 ratio, e.g. if your upgrade wants 20 higher level scrapts you can use 400 lower level scraps instead.
The same thing happens for dusts, shards and crystals, i.e. 20 of a lower level material will be used instead of 1 higher level material. Your 1325 yellow crystals would effectively be used as if you had (1325/20) = 66 red crystals.