(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 630

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 do 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