General Economic Equilibrium Research Articles

Classical thermodynamics and economic general equilibrium theory

A long history of analogy making between neoclassical economics and physical thermodynamics has unfortunately served to obscure two important relations between the two fields: their definitions of equilibria stem from essentially the same three axioms for the mathematical representations of systems, while the classes of transformation each has chosen to emphasize, and their responses to the problem of path dependence, have led them to very different interpretations of duality in those representations. Despite these conventional differences, we show that economies in which all agents have preferences quasi-linear in some good have a trading-constraint structure isomorphic to the structure of physical systems with classical thermodynamic equations of state. Exact equivalents of thermodynamic potentials, including entropy, can be constructed, and function as the economic counterparts to free energies. Quasi-linear economies are the most general in which the Walrasian idea of price formation as an analog of force balance can be realized. More general economic models raise the same methodological problems as more complex physical models that exhibit path-dependence. We show how the degree of aggregatability of an economic model corresponds to which properties of equilibria retain path-independence, and to the extent to which a social-welfare function exists. A new contour money-metric utility defines the maximal generalization of social-welfare functions in arbitrary economies, but depends on the endowments and composition of the economy in non-quasi-linear cases, and is limited to one-dimensional contours of equilibria in non-aggregatable cases. The differences between economic and thermodynamic methodology lies in the economic focus on the irreversible movement from initial disequilibrium endowments to equilibrium through voluntary trade, in contrast to the thermodynamic recognition that only reversible transformations lead to measurement of system structure. The consequences of respecting reversibility for economic method are sketched, and alternative interpretations of the Walrasian notion of wealth preservation are presented.

Pareto’s optimum in models of general economic equilibrium with the asset market

A model of the general economic equilibrium of sequential structures includes the asset market, where assets are instruments of sequential income redistribution. The model should explain relative prices of commodities, on one hand, and establish the asset pricing as an instrument of income redistribution, on the other, enabling the analysis of sequential income transfers. This paper mainly researches Pareto?s optimum of a defined mathematical model of the general economic equilibrium in both complete and incomplete asset markets. The existence of the latter partly disables an economic system to transfer income through time sequences properly, which results in equilibrium allocations not reaching Pareto?s optimum. .

Constrained Inefficiency in Gei: a Geometric Argument

In this paper we use global analysis to study the welfare properties of general equilibrium economies with incomplete markets (GEI). Our main result is to show that constrained Pareto optimal equilibria are contained in a submanifold of the equilibrium set. This result is explicitly derived for economies with real assets and fixed aggregate resources, of which real numeraire assets are a special case. As a by product of our analysis, we propose an original global parametrization of the equilibrium set that generalizes to incomplete markets the classical one, first, proposed by Lange (1942).

Trading constraints penalizing default: A recursive approach

This paper proves existence of an ergodic Markov equilibrium for a class of general equilibrium economies with infinite horizon, incomplete markets, and default. Agents may choose to deny their liabilities and face trading constraints that depend on the adjusted amount of past default on each asset. These constraints replace the usual utility penalties and explore intertemporal tie-ins that appear in dynamic economies. The equilibrium prices and solvency rates present stationary properties that are usually required in econometric models of credit risk.

Equilibrium, Disequilibrium and Time in Walras' Economics

Walras' theory of general economic equilibrium undergoes deep changes over the twenty-six years elapsing from the date when Walras' first significant theoretical contribution is published (1874) and the date when the fourth edition of his fundamental work, the Elements d'economie politique pure, eventually appears (1900). In this paper we reconstruct the many steps characterizing the twisted evolution of Walras' thought concerning equilibrium, disequilibrium, and time in economics. Our reconstruction shows how difficult it is for Walras to free his analysis from the constraints initially imposed on it by a pre-analytic vision marked by a strong, almost naif, descriptive realism, at least as far as the representation of the competitive market mechanism is concerned. As a matter of fact, Walras very early, albeit only confusedly, arrives at perceiving the theoretical, analytical and epistemological difficulties undermining his analysis of the tâtonnement processes associated to his various equilibrium models, but he hesitates to face such issues squarely lest this would force him to give up the allegedly realistic justifications of his theory. As far as the pure exchange model is concerned, Walras, under the pressure of external criticism, soon enough (i.e., since 1885) yields to the requirements of the analysis, by explicitly endorsing the so-called no-trade-out-of-equilibrium assumption, as well as the associated interpretation of the tâtonnement process in exchange as a purely virtual equilibration process in time, supporting an instantaneous equilibrium notion. As far as the production models are concerned, on the contrary, Walras strenuously resists giving up the pseudo-realistic assumptions permeating his analysis of the tâtonnement process in production at least up to the third edition of the Elements (1896): such analysis is essentially based on the idea that the tâtonnement process in production should be interpreted as actual equilibration process in real time, supporting a stationary equilibrium notion. Yet, due to his late realization of the logical contradictions engendered by his assumptions concerning this sort of tâtonnement process and equilibrium notion, hardly (if at all) compensated by a few dubious gains in terms of descriptive realism, Walras eventually resolves, in the fourth edition of the Elements, to renounce all pseudo-realistic pretence: in the 1900 edition, in fact, he adopts a novel, openly unrealistic assumption, the so-called hypothese des bons, which turns all tâtonnement processes, including the one concerning production, into virtual processes in time, supporting a generalized notion of instantaneous equilibrium of the temporary type.

Opportunity and Social Mobility

The fact that the children of rich parents have better economic prospects than the children of poor parents (unequal opportunity) is generally thought to be one of the weak points of modem capitalist societies. The ability of the descendants of poor families to eventually become rich and the descendants of rich families to eventually become poor (social mobility) is commonly considered to be one of the strong points of these societies. Here, I argue that both of these characteristics are, in fact, necessary implications of an efficient societal arrangement when incentives to work hard must be provided. I argue this point using a generational version of the model of Phelan and Townsend (1991), an infinitely repeated, general equilibrium economy with incentive constraints. In my model, each household's stochastic output is a function of its level of effort. Since effort is assumed to be costly and privately observed (households can shirk), higher than minimal effort levels must be induced by making a household's present or future consumption dependent on the household's observed output history. A large literature considers models similar to this (including Green, 1987; Atkeson and Lucas, 1992; Phelan, 1994, 1995; Wang, 1995; Hopenhayn and Nicolini, 1997; Khan and Ravikumar, 2002). The main difference between the economies in that literature and here is that here, instead of a household consisting of a single infinitely lived individual, a household consists of a sequence of altruistically linked individuals (a familial dynasty), each of whom lives for one period. This difference affects the appropriate societal ranking of allocations. When households consist of a single infinitely lived individual, allocations can be ranked according to their implied distributions of ex ante lifetime utilities. (If one allocation delivers a distribution of ex ante utilities dominated by another allocation, then the first allocation is inefficient.) However, if a household consists of a sequence of altruistically linked individuals, then the appropriate ranking of allocations is no longer obvious. How those in the first generation rank allocations will, in general, differ from how their descendants rank allocations. This paper addresses this conflict between generations by ranking allocations according to a Rawlsian veil-of-ignorance criterion (Rawls, 1971). That is, here, society seeks to maximize the expected dynastic utility (utility including altruism toward descendants) of an individual who does not know into which generation he will be born and the identity or output levels of his ancestors.1 I argue that this corresponds to a societal ranking, which does

Trade Adjustment and the Composition of Trade

A striking feature of U.S. trade is that both imports and exports are heavily concentrated in capital goods and consumer durables. However, most open economy general equilibrium models ignore the marked divergence between the composition of trade flows and the sectoral composition of U.S. expenditure, and simply posit import and exports as depending on an aggregate measure of real activity (such as domestic absorption). In this paper, we use a SDGE model (SIGMA) to show that taking account of the expenditure composition of U.S. trade in an empirically-realistic way yields implications for the responses of trade to shocks that are markedly different from those of a "standard" framework that abstracts from such compositional differences. Overall, our analysis suggests that investment shocks, originating from either foreign or domestic sources, may serve as an important catalyst for trade adjustment, while implying a minimal depreciation of the real exchange rate.

Financial Leverage Does Not Cause the Leverage Effect

We quantify the effect of financial leverage on stock return volatility in a dynamic general equilibrium economy with debt and equity claims. We study the effects of financial leverage on the market portfolio, and on a small firm with idiosyncratic and market risk. In an economy with both a constant interest rate and constant price of risk, financial leverage generates little variation in stock return volatility at the market level but significant variation at the individual firm level. In an economy with more realistic variation in interest rates and the price of risk, there is significant variation in stock return volatility at the market and firm level. In such an economy, financial leverage has little effect on the dynamics of stock return volatility at the market level. Financial leverage contributes more to the dynamics of stock return volatility for a small firm.

Regional Policy and Long Term Care Program

The population's indicators predict a constant increase in the demand for health care and welfare related services, at least with reference to the most developed countries. In Italy the provision of the aforementioned services is devoluted to the local tier of government. This work focuses on the problem of financing the greater expenditure for elderly not self-sufficient people. The issues at stake concern on the one hand the analysis of the expenditure side and on the other hand the problem of a regional public sector financing. Two alternative policies are implemented in a general economic equilibrium framework. They regard two local taxes, respectively the regional additional taxation on income (IRPEF)and the regional taxation on production (IRAP). The study points out the efficiency and effectiveness effects of the manoeuvres, focusing both on the market distortions and on the regressive effects. Finally, by a welfare analysis, the net impact (i.e., levy compared with subsidies) on families, grouped according to their income class, is investigated.

Endogenous market incompleteness with investment risks

This paper studies a general equilibrium economy in which agents have the ability to invest in a risky technology. The investment risk cannot be fully insured with optimal contracts because shocks are private information. We show that the presence of investment risks lead to under-accumulation of capital relative to an economy where idiosyncratic shocks can be fully insured. We also show that the availability of state-contingent (optimal) contracts – compared to simple debt contracts – brings the aggregate stock of capital close to the complete markets level. Institutional reforms that make possible the use of these contracts have important welfare consequences.

Distributive Justice and the Rules of the Corporation: Partial Versus General Equilibrium Analysis

Abstract:Progressives have advocated reforms of rules governing corporations to achieve greater distributive justice, but Maitland (2001) has argued that corporate rules are distributively neutral and that changing the rules will have no long run impact on distributive justice. These different conclusions stem from the use of two different methods of economic analysis, partial equilibrium and general equilibrium models. A change in the rules governing corporations in a “large” sector of the economy is appropriately analyzed using a general equilibrium analysis, supporting the conclusion that changes in the rules may affect distributive justice in the long run. However, a partial equilibrium analysis of a change in the rules of corporations affecting a “small” part of the economy such as a single firm or even all firms in a small state supports the claim that such changes cannot affect distributive justice.

Coasian equilibrium

We consider a general equilibrium economy with public goods and externalities. Following Boyd and Conley (1997), we treat externality markets directly instead of indirectly through Arrovian commodities. Because such direct externality markets are not subject to the nonconvexities that Starrett [Starrett, D., 1972. Fundamental nonconvexities in the theory of externalities. Journal of Economic Theory 4, 180–199] shows are fundamental to Arrow’s externality markets, this new approach admits the use of largely standard methods to prove welfare and existence theorems in an economy with externalities. We extend the Boyd and Conley model to allow firms to benefit from public goods and be damaged by externalities, and to allow consumers to produce externalities. We state a first welfare theorem and prove the existence of a competitive equilibrium. Taken together, this can be viewed as a type of general equilibrium Coase theorem. Considered as a special case, these theorems also represent a significant generalization of existing results for pure public goods economies.

General Equilibrium with Endogenous Securities and Moral Hazard

This paper studies a class of general equilibrium economies in which the individuals' endowments depend on privately observed effort choices and the financial markets are endogenous. The environment is modeled as a two-stage game. Individuals first make strategic financial-innovation decisions. They then act in a Radner-type economy with the previously designed securities. Consumption goods, portfolios, and effort levels are chosen competitively (i.e., taking prices as given). An equilibrium concept is adapted for these moral hazard economies and its existence is proven. It is shown through an example how incentive motives might lead to the endogenous emergence of financial incompleteness.

Diversification and Ownership Concentration

We consider a mean-variance general equilibrium economy where the expected returns for controlling and non-controlling shareholders are different because the former are able to divert a fraction of the profits. We find that when investor protection is poor, asset return correlation affects ownership structure in a positive way. Higher return correlation lowers the benefits of diversification which causes a higher investment by the controlling shareholder in his asset and a lower investment by the non-controlling shareholders. The empirical analysis supports the predictions of the model. In particular, controlling for measures of the quality of the investor protection, the legal origin of the countries, and other structural variables as in a previous study by La Porta et al. (1998) we find that equity ownership is significantly more concentrated in countries where stock return correlation is higher, and that the magnitude of this effect is larger in countries where investor protection is poorer.

Shareholders Unanimity With Incomplete Markets

Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually assume that consumers, rather than firms, own and accumulate physical capital. This assumption, while convenient, is without loss of generality only if the asset market is complete. When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the general equilibrium economy analyzed here consumers face idiosyncratic labor income risk and trade firms' shares in the stock market. A firm's shareholders decide how much of its earnings to invest in physical capital and how much to distribute as dividends. The return on a firm's capital investment is affected by an aggregate productivity shock. The paper contains two main results. First, if the production function exhibits constant returns to scale and short-sales constraints are not binding, then in a competitive equilibrium a firm's shareholders will unanimously agree on the optimal level of investment. Thus, the allocation of resources in this economy is the same as in an economy where consumers accumulate physical capital directly. Second, when short-sales constraints are binding, instead, the unanimity result breaks down. In this case, constrained shareholders prefer a higher level of investment than unconstrained ones.

Does Local Market Correlation Matter for Ownership Structure and Control Rights?

We consider a general-equilibrium Capital Asset Pricing Model economy where the expected returns for controlling and non-controlling shareholders are different because the first can divert part of the profits. We show that local market correlation (the correlation between the returns of the risky assets) matters in determining ownership structure and control rights because it affects the loss from foregone diversification opportunities arising from concentrated ownership and the level of control benefits that non-controlling investors are willing to tolerate to achieve diversification. The empirical analysis support the model's conclusions. In particular our empirical findings on a group of countries are: ownership is more concentrated the higher is local market correlation; firm size and per capita income are higher the lower is local market correlation and control rights are affected by local market correlation.

Rozšířený koncept všeobecné ekonomické rovnováhy

The concept of utility is interpreted (in M. Friedman's intentions) as the present value of future income from investments in human capital occurring in the framework of personal consumption. In this sense consumption is regarded as a productive phenomenon. On this basis the concept of general economic equilibrium can be classified. On the one hand, instead of the disputable theory of social welfare the role of capital market in parallel creating equilibrium between supply and demand of investments opportunities, on the other hand, demand and supply of investment funds is applied. The proposed concept is applicable to explain current changes connected with the transition to knowledge based society.

Crises in Competitive versus Monopolistic Banking Systems

We study a monetary, general equilibrium economy in which banks exist because they provide inter-temporal insurance to risk-averse depositors. A "banking crisis" is defined as a case in which banks exhaust their reserve assets. This may (but need not) be associated with liquidation of a storage asset. When such liquidation does occur, the result is a real resource loss to the economy and we label this a "costly banking crisis." There is a monetary authority whose only policy choice is the long-run, constant rate of growth of the money supply, and thus the rate of inflation. Under different model specifications, the banking industry is either a monopoly bank or a competitive banking industry. It is shown that the probability of a banking crisis may be higher either under competition or under monopoly. This is shown to depend on the rate of inflation. In particular, if the nominal rate of interest (rate of inflation) is below (above) some threshold, a monopolistic banking system will always result in a higher (lower) crisis probability. Thus, the relative crisis probabilities under the two banking systems cannot be determined independently of the conduct of monetary policy. We further show that the probability of a costly banking crisis is always higher under competition than under monopoly. However, this apparent advantage of the monopoly banking is strictly due to the fact that it provides relatively less valuable inter-temporal insurance.

Central Bank Design in General Equilibrium

We study the effects of alternative institutional arrangements for the determination of monetary policy in the context of a capital-theoretic, general equilibrium economy. We consider three institutional arrangements for determining monetary policy. The first, unconditional majority voting, always leads to a substantial inflation bias. The second, a simple form of bargaining which we interpret as a policy board, generally improves on the unconditional majority voting outcome. Finally,we consider a constitutional rule which always achieves the social optimum.

General Equilibrium and Endogenous Creation of Asset Markets

This paper studies a class of general equilibrium economies in which asset markets arise as choice of financial intermediaries. The economy is modeled as a two stage game as in Bisin[8]. In the first stage intermediaries set up the financial structure according to the expectation that they have for the second stage outcome. In the second stage, consumers behave as price takers in the commodity market and in the previously created assets market. We consider that intermediaries form their expectations using continuous random selections from the second stage equilibrium correspondence (differently from Bisin[8] where an endogenous beliefs expectation was used). We establish the existence of equilibria in mixed strategies and moreover, we obtain an approximate equilibria in pure strategies by modeling explicitly the incomplete information that each intermediary has about others intermediaries fixed cost functions.