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CHAPTER 16 • General Equilibrium and Economic Efficiency 605 Karen’s Food 10F OK 6C D James’s Clothing Karen’s Clothing C U J3 B UK3 OJ James’s Food A UK2 UK1 U 2J U 1J 6C 10F F IGURE 16.5 EFFICIENCY IN EXCHANGE The Edgeworth box illustrates the possibilities for both consumers to increase their satisfaction by trading goods If A gives the initial allocation of resources, the shaded area describes all mutually beneficial trades food and clothing that would make both James and Karen better off than at A In other words, it describes all possible mutually beneficial trades Starting at A, any trade that moved the allocation of goods outside the shaded area would make one of the two consumers worse off and should not occur The move from A to B was mutually beneficial But in Figure 16.5, B is not an efficient point because indifference curves U 2J and U2K intersect In this case, James’s and Karen’s MRSs are not the same and the allocation is not efficient Starting at B, James would prefer to give up some food to obtain additional clothing He would be willing to make any trade that left him no worse off and hopefully gave him some additional utility, and there are many trades that would so Karen, on the other hand, would be willing to give up some clothing to obtain more food, and there are many such trades that would make her better off This situation illustrates an important point: Even if a trade from an inefficient allocation makes both people better off, the new allocation is not necessarily efficient Suppose that from B the additional trade is made, with James giving up another unit of food to obtain another unit of clothing and Karen giving up a unit of clothing for a unit of food Point C in Figure 16.5 gives the new allocation At C, the MRSs of both people are identical, because at point C the indifference curves are tangent Trading food for clothing and thereby moving from point B to point C has allowed James and Karen to achieve a Pareto efficient outcome, and they will both be better off When the indifference curves are tangent, one person cannot be made better off without making the other person worse off Therefore, C represents an efficient allocation Of course, C is not the only possible efficient outcome of a bargain between James and Karen For example, if James is an effective bargainer, a trade might change the allocation of goods from A to D, where indifference curve U 3J is
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