Pareto Superior Allocation Research Articles

MONEY AND CREDIT REMIX

Money and credit are ubiquitous in actual economies, but there is an active theoretical debate on whether they are both necessary if they can both be used in all transactions. Recently, Gu et al. (2016) have shown that money and credit cannot be simultaneously essential and debt limits do not matter for the determination of real allocations in a class of monetary economies. In this paper, we revisit their irrelevance result in a monetary economy based on Lagos and Wright (2005), which exhibits a misallocation of liquidity that is common in search models of money. We show that monetary loans, which naturally require the use of both money and credit, implement Pareto superior allocations in which the size of debt limits matters.

An Application of Distribution-Neutral Fiscal Policy

Distribution neutral fiscal policy refers to a structure of taxes and transfers that keep the income distribution unchanged even after positive or negative shocks to an economy. This is referred to as a Strong Pareto Superior (SPS) allocation which improves the standard Pareto criterion by keeping the degree of inequality, but not the absolute level of income intact. We apply this methodology to India to compute SPS tax rates and determine their proximity to actual tax rates. Limited available data on income and expenditure shows that the official policies so far are close to desired benchmark level. Our methodological contribution will be enriched further with more detailed income tax and transfer data.

Improving matching under hard distributional constraints

Distributional constraints are important in many market design settings. Prominent examples include the minimum manning requirements at each Army branch in military cadet matching and diversity considerations in school choice, whereby school districts impose constraints on the demographic distribution of students at each school. Standard assignment mechanisms implemented in practice are unable to accommodate these constraints. This leads policymakers to resort to ad hoc solutions that eliminate blocks of seats ex ante (before agents submit their preferences) to ensure that all constraints are satisfied ex post (after the mechanism is run). We show that these current solutions ignore important information contained in the submitted preferences, resulting in avoidable inefficiency. We then introduce new dynamic quotas mechanisms that result in Pareto superior allocations while at the same time respecting all distributional constraints and satisfying important fairness and incentive properties. We expect the use of our mechanisms to improve the performance of matching markets with distributional constraints in the field.

Short sales, destruction of resources, welfare

A reduction in the output of productive assets (trees) in some contingencies may expand the range of risks spanned by the payoffs of assets and allow for better risk sharing; which may compensate for the loss of output and support a Pareto superior allocation. Surprisingly, if short sales of assets are not allowed, improved risk sharing that results from the destruction of output does not suffice to support a Pareto superior allocation.

Market Design Under Distributional Constraints: Diversity in School Choice and Other Applications

Distributional constraints are important in many market design settings. Prominent examples include the minimum manning requirements at each Army branch in military cadet matching and diversity considerations in school choice, whereby school districts impose constraints on the demographic distribution of students at each school. Standard assignment mechanisms implemented in practice are unable to accommodate these constraints. This leads policymakers to resort to ad-hoc solutions that eliminate blocks of seats ex-ante (before agents submit their preferences) to ensure that all constraints are satisfied ex-post (after the mechanism is run). We show that these current solutions ignore important information contained in the submitted preferences, resulting in avoidable inefficiency. We then introduce new dynamic quotas mechanisms that result in Pareto superior allocations while at the same time respecting all distributional constraints and satisfying important fairness and incentive properties. We expect the use of our mechanisms to improve the performance of matching markets with distributional constraints in the field.

Intrafamily bargaining and love

Popular culture and common wisdom testify that the way partners in a relationship feel for one another very much depends on how they treat each other. This paper posits the hypothesis that altruism or love in a relationship is endogenous to the actions of the partners and studies how this influences allocations and efficiency in a bargaining model of household decision-making. The main results are that agents treat their partner in a kinder way than without endogenously evolving love, this leads to more equitable allocations in household decision making and greater intertemporal efficiency. There are two mechanisms at work: agents treat their partner nicely to avoid retribution by a less loving partner in the future; and they treat the partner nicely so that the kind reciprocal behavior raises their own love towards the partner, which lets them enjoy higher utility. As to love, two interpretations emerge: love is a commitment device by which couples can implement Pareto superior allocations; and love is an investment good in the sense that costly nice behavior towards the partner today may ensure higher levels of trust and efficiency in the future.

Emission trading or proportional carbon tax: a quest for more efficacious emission control

BackgroundTwo alternative procedures currently exist for efficient carbon dioxide (CO2) emissions control: carbon emission trading and proportional carbon tax. This article explores which of the two is more desirable and efficacious.ResultsCompared to emission trading, the equilibrium under a universal proportional carbon tax achieves Pareto superior allocation. In addition, the price of a unit of CO2 emissions is much higher in the case of a universal proportional carbon tax than for bilateral emissions trading.ConclusionsThis paper reveals the superiority of a universal proportional carbon tax over the emissions trading in terms of the efficiency of CO2 emissions control. However, deciding and abiding by a universal tax rate is likely to require great political will. In this sense, viewed in the current context, such a tax scheme is visionary. Gradualism is unavoidable. It is far more desirable to expand the network of the upcoming trilateral carbon trading network steadily rather than leaving the global economy to the laissez-faire situation.

Idiosyncratic risk and financial policy

In economies subject to uninsurable idiosyncratic risks, competitive equilibrium allocations are constrained inefficient: reallocations of assets support Pareto superior allocations. This is the case even if the asset market for the allocation of aggregate risks is complete.

Transaction costs and planner intervention

In this paper, I examine a two-period general equilibrium model in which transaction costs are incurred whenever financial contracts are traded. These transaction costs are real and convex. The presence of these transaction costs results in a Pareto inefficient equilibrium allocation. Attempting to fix this problem, the planner will intervene by scaling the transaction costs either up or down. The intervention must satisfy fiscal balance meaning that the summed value of transaction costs will remain constant. I prove that over a generic subset of household utility functions and endowments and subject to an upper bound on the number of household types, there exists an open set of planner interventions that lead to a Pareto superior allocation.

Welfare-Improving Credit Controls

Credit controls are generally believed to result in an inefficient allocation of resources. This paper presents a counterexample. It displays a general equilibrium, multi-good model with spatial separation for which steady state equilibria exist in which both cash (i.e. fiat currency) and trade credit are used in exchange. Transaction costs, restrictions on the timing of trade, and a positive nominal interest rate cause the laissez-faire equilibrium to be non-optimal. A quantitative restriction on the use of trade credit can yield a Pareto superior allocation.

The politics of soft credit in post‐Soviet Russia

AN ESSENTIAL ELEMENT of economic reform in post-communist states is to create efficient capital markets. In developed capitalist orders, such markets are 'at the centre of the brain of the entire economic system'.' Banks, stock and bond brokers, mutual funds, venture capital firms and other financial institutions compete to attract investment resources and to direct them to uses where expected profits are highest. Through their actions, Pareto superior allocations are achieved and growth rates rise.2 Soviet-type economies were 'redistributive systems'.3 Capital markets, efficient or otherwise, did not exist. Instead, financial resources were allocated and continually redistributed through a combination of planning, informal bargaining and malfeasance. Investment plans were adopted centrally and disaggregated by lower-level planning bodies and ministries. They were financed almost entirely through budgetary transfers. Short-term credit for working capital was extended to enterprises by the state bank within limits established by the credit plan. In turn, almost all enterprise profits were remitted to the budget for future reallocation.4 In practice, however, central priorities were reshaped from below. Agents concealed and distorted information, reinterpreted directives in the implementation, and sometimes simply disobeyed principals higher up in the hierarchy. Plan assignments were repeatedly renegotiated, sometimes as late as in December of the planned year.5 All the parameters of financial redistribution-investment capital, credit limits, prices-were subject to bureaucratic lobbying, rendering budget constraints 'soft'.6 An 'administrative market' of bartered favours evolved, along with a 'shadow economy' of diverted goods and resources.7 Since 1987 the Soviet-and then the Russian-banking system has undergone reforms.8 The monobank system was first replaced by a two-tiered structure of a central bank and five specialised banks.9 Then the specialised banks were commercialised and transformed into joint stock companies, with regional and local branches often becoming independent. With the dissolution of the Soviet Union in December 1991, the State Bank divided into 15 central banks. In parallel, about 1700 private

Welfare-improving credit controls

Credit controls are generally believed to result in an inefficient allocation of resources. This paper presents a counterexample. It displays a general equilibrium, multi-good model with spatial separation for which steady state equilibria exist in which both cash (i.e., fiat currency) and trade credit are used in exchange. Transaction costs, restrictions on the timing of trade, and a positive nominal interest rate cause the laissez-faire equilibrium to be nonoptimal. A quantitative restriction on the use of trade credit can yield a Pareto-superior allocation.

Class shares and economies of scope

This paper examines the allocative role of class shares that pay dividends based upon the performance of the individual activities of multi-activity firms. The firms considered operate under economies of scope and technological uncertainty in an incomplete asset market. Investor unanimity about the choice of production plans and a constrained Pareto optimum are attained when all firms in the economy issue a class of shares for each of their activities. Partial issuance of class shares leads to a Pareto superior allocation if the ensuing changes in production plans are individually rational.

Fiat money as a store of value in an experimental market

The time path of the value of fiat money is studied in an experimental market. In this market players can achieve Pareto superior allocations by trading goods for money at fixed nominal prices. However, the finite horizon makes the value of money unstable as players learn not to hold money near the horizon. We investigate the value of money in stationary replications of the model where subjects trade off the increased value of money as a medium of exchange against the chances of holding worthless money (as the role of money as a store of value deteriorates).

Comment: General Competitive Analysis in an Economy with Private Information

Prescott and Townsend (1984) extend the literature on general equilibrium theory to economies in which agents have private information about their preferences. They examine the extent to which the classical welfare theorems carry over in this environment. The existence of nonverifiable information imposes limits on the economy's contract structure. Contracts cannot be written to require an agent to reveal information unless truthful revelation is optimal. Incentive compatiblity constraints, typically nonlinear, are thereby introduced into the corresponding planner's problem. As a result, the space of feasible deterministic allocations is typically not convex. The authors circumvent this problem by allowing for random allocations, where the planner is choosing over the space of probability distributions of consumption allocations. The incentive compatibility constraints in this space are linear in the planner's choice variables, rendering the set of feasible consumption allocations convex. Some of the attainable random allocations Pareto dominate the set of incentive-feasible allocations attainable via deterministic allocation rules. Randomized allocations have two functions. They convexify the planner's choice set, and they may allow for Pareto superior allocations to be achieved. Prescott and Townsend's presentation may leave readers with the misleading conclusion that the nonconvexity of the choice set under deterministic allocations is necessary for random allocations to be Pareto superior. But, one can attain Pareto superior allocations with lotteries even when the choice set under deterministic allocation rules is convex. This note demonstrates that Prescott and Townsend's own example has this property.

Overlapping expectations and Hart's conditions for equilibrium in a securities model

Hart ( J. Econ. Theory 9 (1974), 293–311) gave conditions for equilibrium to exist in a securities model where each agent undertakes asset transactions to maximize expected utility of wealth. These conditions rule out agents wanting to undertake unbounded balanced transactions to reach a Pareto superior allocation given their expectations. With mild extra assumptions to make agents unwilling to risk incurring unbounded losses on their portfolios, Hart's conditions become equivalent to an assumption of “overlapping expectations,” which is comparable to a much weaker form of Green's “common expectations” ( Econometrica 41 (1973), 1103–1124).

Welfare and Savings Effects of Indexation

WE SEEK TO ACCOMPLISH two goals in this paper. First, we provide a clarifying discussion of the welfare implications of the introduction of indexed debt contracts in a financial market, an issue that has been discussed in [ 1, 9, 11] in this journal, as well as in [3, 12, 13]. We show that doubts about the Pareto-superiority of indexed debt contacts that have been raised in some of this literature are methodologically incorrect, and that, not surprisingly, the introduction of indexed debt contracts at an equilibrium of the nonindexed economy does indeed lead to a Pareto-superior allocation. Second, we derive and examine the implications of suffcient general-equilibrium conditions for (aggregate) savings to rise or decline as a result of the introduction of indexed debt. These conditions allow for general utility functions and take into account the fact that, in general, all prices may change as a result of the introduction of a contract that changes the asset economy. As a result, the conclusions derived are, in their rigor, generality and (as it turns out) simplicity, a significant improvement on the results of Levhari and Liviatan [4, 5] on the same issue. As in most of the literature in this area, our analysis is carried out in the framework of a two-period mean-variance model of consumption and portfolio choice, although