(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 4.
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
0

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)