Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

B
E
3
A
C
1
A
2
B
2
A
1
B
0
A
0
B
X
Y
P
R
Q
C
1
a
Y
b
Y
a
X
b
X

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off having moved from B
1
to B
3
. It is only when they move from E to 
Q that both are on higher indifference curves. 
P, Q and R are thus the three conceivable points of 
exchange. The contract curve CC
1
is the locus of these points of 
tangency which shows the various position of exchange that 
equalise the marginal rates of substitution of X and Y. any point on 
the CC
1 
curve, therefore, satisfies this optimum condition of 
exchange. 
6.4.2 Efficiency in Production: 
The second condition for Pareto optimality related to 
efficiency in production. There are three allocation rules for 
demonstrating efficiency in production under perfect competition. 
Rule One relates to the optimum allocation of factors. It requires 
that the marginal rate of technical substitution (MRTS) between any 
two factors must be the same for any two firms using these factors 
to produce the same product. Suppose there are two firms A and B 
that use two factors: labour (L) and capital (K) and produce one 
product. Given the prices of the two factors, a firm is in equilibrium 
under perfect competition when the slope of an iso-quant equals 
the slope of the iso-cost line. The slope of an iso-quant is the 
MRTS of labour and capital, and the slope of the iso-cost line is the 
ratio of the prices of labour and capital. Thus the condition of 
equilibrium for firm a is 
A
MRTS
P / P
L
K
LK
and that of firm B is 
B
MRTS
P / P
L
K
LK
. 
Therefore, rule one for efficiency in production is 
A
B
MRTS
MRTS
P / P
L
K
LK
LK