In a two-person, two-product economy with two factors of production, these three types of

efficiency are achieved when three conditions hold: productive efficiency demands that the rate of

Technical substitution for the two products must be equal, to ensure a unit of one factor of production

Is worth the same amount in terms of the other factor whichever product it is used in. Otherwise,

Factors could be swapped between products and extra output gained. Second, that the marginal

Rate of substitution must be equal for both consumers; otherwise, the consumers could swap

Commodities to their mutual benefit. Third, allocative efficiency requires that the marginal rate of

transformation must equal the marginal rate of substitution: if consumers feel one banana is worth

Two apples, and producers can make one extra banana at the sacrifice of only one apple, it will pay

Society for them to produce one apple less and one extra banana, and to go on making that switch,

Until eventually consumers tire of bananas and value apples more highly than they did; and land

Suitable for banana production will be so marginal that for every bit of land removed from apples,

Hardly any bananas will be produced. At this stage, the two rates of substitution will be equal.

Economic efficiency on these criteria will exist in an economy in which perfect competition