(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 649

624 PART • 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 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 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 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