In a perfectly competitive economy, production and consumption will both be Pareto optimal when the economy operates at a point where output levels are below equilibrium.

Option 1: General equilibrium refers to a state in which demand equals supply in all markets. While general equilibrium is important for efficient resource allocation, it does not guarantee Pareto optimality. Therefore, this option is not correct in this context.

Option 2: The correct answer. When output levels are below equilibrium, it means that producers are not fully utilizing their resources. This can lead to inefficiencies and wasted potential, resulting in a suboptimal allocation of resources. In this scenario, both production and consumption can be improved without reducing the well-being of any individual. Therefore, operating below equilibrium can help achieve Pareto optimality.

Option 3: When output levels are above equilibrium, it indicates that producers are overproducing and potentially using resources beyond their efficient levels. This can lead to surpluses, shortages, or other inefficiencies, which are not consistent with Pareto optimality.

Option 4: Consumption being less than output implies that producers are keeping a significant portion of the output for themselves rather than distributing it for consumption. This does not align with the concept of Pareto optimality, which focuses on