What is meant by the claim that a competitive market equilibrium is Pareto efficient?

Expert Solution

Pareto Efficiency implies that there are no other allocations in which some individual can be made better-off and no individual is worse-off.

The Claim: competitive market equilibrium is Pareto efficient implies that each and every trader in the market cares only about their own consumption bundles. They do no enjoy any benefit from the consumption of other trader's bundle.

There can be many Pareto efficient allocations where the following condition is satisfied:

MRS of Individual 1 = MRS of Individual 2 = ...... = MRS of Individual N

However, competitive equilibrium allocation is one of those pareto efficient allocations which satisfies the following condtion:

MRS of Individual 1 = MRS of Individual 2 = ...... = MRS of Individual N = Price Ratio

Where Price Ratio is the slope of the Budget Constraint

So, this claim implies that every competitive market equilibrium is Pareto Efficient as it first equalizes the MRS of all individuals which is the optimal condition for pareto efficient allocation.

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Rahul Sunny answered 6 months ago

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