I'm guessing in you database.yml file you have this:
development:
  adapter: mysql

So you need todo this:

# gem install mysql or if mysql is in a none standard area you need to
point to mysql_config like this:
# gem install mysql -- --with-mysql-config=/usr/local/mysql/bin/
mysql_config (or where ever you have mysql installed)

Show us output from the following:

gem list
inside of you application => rake gems



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