The indifference curves J1 of Jane and K 1 of Kelvin first intersect at point X, where
Jane has more apples than Kelvin does, Kelvin has more bananas than Jane does,
and they are willing to trade with each other at the prices P b and Pa. After trading
both Jane and Kelvin move to an indifference curve which depicts a higher level of
utility, J2 and K2. The new indifference curves intersect at point E. The slope of the
tangent of both curves equals -Pb/Pa.
And the MRSJane=Pb/Pa; MRSKelvin=Pb/Pa. The marginal rate of substitution of Jane
equals that of Kelvin. Therefore the 2 individuals society reaches Pareto efficiency,
where there is no way to make Jane or Kelvin better off without making the other
worse off.
Note that microeconomic analysis does NOT assume additive utility nor does it
assume any interpersonal utility tradeoffs. Efficiency therefore refers to the absence
of Pareto improvements. It does not in any way opine on the fairness of the
allocation (in the sense of distributive justice or equity). An 'efficient' equilibrium
could be one where one player has all the goods and other players have none (in an
extreme example). This is efficient in the sense that one may not be able to find a
Pareto improvement - which makes all players (including the one with everything in
this case) better off (for a strict Pareto improvement), or not worse off.
References [edit]
1. ^ Callan, S.J & Thomas, J.M. (2007). 'Modelling the
Market Process: A Review of the Basics', Chapter 2
in Environmental Economics and Management: Theory,
Politics and Applications, 4th ed., Thompson
Southwestern, Mason, OH, USA
Economic equilibrium
Allocative efficiency
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