(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 649
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624 PART 4 • Information, Market Failure, and the Role of Government
These conditions are important; in each of these three cases, you should review
the explanation of the conditions in this chapter and the underlying building
blocks in prior chapters.
Recall from §3.3 that consumer satisfaction is maximized when the marginal
rate of substitution of food
for clothing is equal to the
ratio of the price of food to
that of clothing.
1. Efficiency in exchange: All allocations must lie on the exchange contract
curve so that every consumer’s marginal rate of substitution of food for
clothing is the same:
MRS JFC = MRSKFC
A competitive market achieves this efficient outcome because, for consumers, the tangency of the budget line and the highest attainable indifference
curve ensure that:
MRS JFC = PF/PC = MRSKFC
2. Efficiency in the use of inputs in production: Every producer’s marginal rate
of technical substitution of labor for capital is equal in the production of
both goods:
MRTSFLK = MRTSCLK
Recall from §7.3 that profit
maximization requires that
the marginal rate of technical substitution of labor for
capital be equal to the ratio
of the wage rate to the cost
of capital.
A competitive market achieves this technically efficient outcome because
each producer maximizes profit by choosing labor and capital inputs so
that the ratio of the input prices is equal to the marginal rate of technical
substitution:
MRTSFLK = w/r = MRTSCLK
3. Efficiency in the output market: The mix of outputs must be chosen so that the
marginal rate of transformation between outputs is equal to consumers’
marginal rates of substitution:
MRTFC = MRSFC (for all consumers)
In §8.3, we explain that
because a competitive firm
faces a horizontal demand
curve, choosing its output so
that marginal cost is equal to
price is profit-maximizing.
A competitive market achieves this efficient outcome because profitmaximizing producers increase their output to the point at which marginal
cost equals price:
PF = MCF, PC = MCC
As a result,
MRTFC = MCF/MCC = PF/PC
But consumers maximize their satisfaction in competitive markets only if
PF/PC = MRSFC (for all consumers)
Therefore,
MRSFC = MRTFC
