(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 642

CHAPTER 16 • General Equilibrium and Economic Efficiency 617 Efficiency in Output Markets When output markets are perfectly competitive, all consumers allocate their budgets so that their marginal rates of substitution between two goods are equal to the price ratio For our two goods, food and clothing, MRS = PF/PC At the same time, each profit-maximizing firm will produce its output up to the point at which price is equal to marginal cost Again, for our two goods, In §3.3, we explain that utility maximization is generally achieved when the marginal rate of substitution of one good for another is equal to the ratio of their two prices PF = MCF and PC = MCC Because the marginal rate of transformation is equal to the ratio of the marginal costs of production, it follows that MRT = MCF/MCC = PF/PC = MRS (16.5) When output and input markets are competitive, production will be output efficient in that the MRT is equal to the MRS This condition is just another version of the marginal benefit–marginal cost rule discussed in Chapter There we saw that consumers buy additional units of a good up to the point at which the marginal benefit of consumption is equal to the marginal cost Here we see that the production of food and clothing is chosen so that the marginal benefit of consuming another unit of food is equal to the marginal cost of producing another unit of food; the same is true for the consumption and production of clothing Figure 16.11 shows that efficient competitive output markets are achieved when production and consumption choices are separated Suppose the market generates a price ratio of P1F/P1C If producers are using inputs efficiently, they will produce food and clothing at A, where the price ratio is equal to the MRT, the slope of the production possibilities frontier When faced with this budget constraint, however, consumers would like to consume at B, where they maximize their satisfaction at the higher indifference curve U2 However, at the price Clothing (units) C1 PF1/PC1 PF*/PC* F IGURE 16.11 A COMPETITION AND OUTPUT EFFICIENCY In a competitive output market, people consume to the point where their marginal rate of substitution is equal to the price ratio Producers choose outputs so that the marginal rate of transformation is equal to the price ratio Because the MRS equals the MRT, the competitive output market is efficient Any other price ratio will lead to an excess demand for one good and an excess supply of the other B C2 C* C U2 U1 F1 In §3.3, we explain that utility maximization is achieved when the marginal benefit of consuming an additional unit of each product is equal to its marginal cost F * F2 Food (units)