Price dynamics in an exchange economy

Abstract

The pure exchange model is the foundation of the neoclassical theory of value, yet equilibrium predictions and models of price adjustment for this model remained untested prior to the experiment reported in this paper. With the exchange economy replicated several times, prices and allocations converge sharply to the competitive equilibrium in continuous double auction (CDA) trading. Convergence is evaluated by comparing the extent of price adjustment within each market replication (or trading period) to the extent of adjustment across trading periods: most observed price adjustment occurs within trading periods, so price adjustment data are evaluated with the Hahn process model (Hahn and Negishi (1962)), which is a disequilibrium model of within-period trades. Estimation demonstrates that the model is consistent with observed price paths within each period of the exchange economy. The model is augmented with an additional assumption - based on observations from this experiment - that the initial trade price in period t+1 is randomly drawn from the interval between the minimum and maximum trade prices in period t. The estimated within-period adjustment rule, combined with this across-period adjustment rule, generates price paths similar to data from an experiment session.