The Blue Dragon first appears in Boletarian Palace, guarding some treasure in a grassy area before the bridge guarded by many soldiers. It cannot be killed here though. It will not actively attack the player, but its swinging tail deals very high physical damage.
The Blue Dragon later appears in Penetrator Archstone, periodically breathing fire as a stationary hazard. It first appears sitting atop the battlements in front of the palace keep; its fire breath is considerably stronger than the Red Dragon's, but it will also kill the Fat Officials along the battlements if they are in the way. Attacking the dragon and causing significant damage to it at this point will make it move to the entrance of the castle. When you advance to finish it off, you may encounter Biorr already battling the dragon.