You are on page 1of 5

22 CHAPTER 3.

ARROW-DEBREU EXCHANGE ECONOMIES

The equilibrium equations can thus be always reduced to L 1 equations


in L 1 unknowns. Since equations are typically nonlinear, having number
of unknowns less or equal than number of independent equations does not
ensure a solution exists.

Theorem 12 (Existence) Let z : L 1 ! RL be a continuous function,


such that p z(p) = 0 for all p. Then there exists p such that z(p ) 0:

Sketch of the proof.


pl + max f0; zl (p)g
Let 'l (p) = PL , l = 1; ::L
j=1 [pj + max f0; zj (p)g]

Note that L 1 is convex and compact, and ' : L 1 ! L 1


. Hence by
the Brouwer Fixed Point theorem there is a xed point p :
p + max f0; zl (p )g
pl = PL l , l = 1; ::L.
j=1 [pj + max f0; zj (p)g]

Then
X
L
zl (p )pl pj + max f0; zj (p )g = zl (p )pl + zl (p ) max f0; zl (p )g
j=1

and summing over l yields:


X
0= zl (p ) max f0; zl (p )g ) zl (p ) 0 for all l = 1; :::; L:
l

Since p satises z(p ) 0 and Walras law, p z(p ) = 0,

zl (p ) < 0 i pl = 0:

But this is impossible under strong monotonicity and hence:

z(p ) = 0:

To properly claim existence of a competitive equilibrium need to face one last


problem: the consumersdemand is not dened for prices on the boundary of
L 1
(when the price of some good is zero). We need
P to use a limit argument,
considering z : L" 1 ! RL , for L" 1 p 2 RL+ : l pl = 1, pl " for all l ,
and taking limits as " ! 0.
3.3. COMPETITIVE EQUILIBRIUM 23

3.3.1 Uniqueness
Existence of a competitive equilibrium can be proved under quite general con-
ditions.3 Equilibria are however unique only under very strong restrictions.
Several examples of such restrictions are listed in the following.

The endowment distribution is Pareto e cient, and hence the only equilib-
rium is autarchic: xi = ! i for all i 2 I:

Preferences satisfy an aggregation condition (so that a representative con-


sumer exists) for all p and for given (mh )H
h=1 :

Aggregate demand satises WARP and equilibria are locally isolated.

Aggregate demand satises the gross substitution property:

p0l > pl and p0j = pj ; for all j 6= l;


=)
0
zj (p ) > zj (p).

Note that gross substitution implies that the law of demand holds at
any equilibrium price. Gross substitution holds for instance for Cobb
Douglas and CES utility functions (provided < 1).

3.3.2 Local uniqueness


Let an economy be parametrized by the endowment vector ! 2 RLI ++ keeping
preferences (ui )i2I xed. Furthermore, normalize pL = 1 and eliminate the
L-th component of the excess demand. Then
L 1
z : R++ RLI
++ ! R
L 1

represents an aggregate excess demand for an exchange economy ! = (! i )i2I 2


RLI
++ .

Denition 13 A p 2 RL++ such that z (p; !) = 0 is regular if Dp z (p; !)


has rank L 1:
3
We shall leave this statement essentially unsubstantiated. General equilibrium theory,
for more than half a century, has considered this as one of its main objectives.
24 CHAPTER 3. ARROW-DEBREU EXCHANGE ECONOMIES

Denition 14 An economy ! 2 RLI ++ is regular if Dp z (p; !) has rank L 1


L 1
for any p 2 R++ such that z (p; !) = 0.

Denition 15 An equilibrium price p 2 RL++1 is locally unique if 9 an


open set P such that p 2 P and for any p0 6= p 2 P , z (p0 ; !) 6= 0:

Proposition 16 A regular equilibrium price p 2 RL++1 is locally unique.

Proof. Fix an arbitrary ! 2 RLI ++ : Since Dp z (p; !) has rank L 1; by


regularity of p, the Inverse function theorem - Local (see Math Appendix)
applied to the map z : RL++1 ! RL 1 , directly implies local uniqueness of p 2
RL++1 .

Proposition 17 Any economy ! in a full measure Lebesgue subset of RLI


++
is regular.

We say then that regularity is a generic property in RLI ++ , as it holds in a


full measure Lebesgue subset of RLI ++ .
Proof. The statement follows by the Transversality theorem (see Math
Appendix), if z t 0: We now show that z t 0: Pick an arbitrary agent
i 2 I: It will be su cient to show that, for any (p; !) 2 RL++1 RLI ++ such
that z(p; !) = 0; we can nd a perturbation d! i 2 RL such that dz =
D!i z(p; !)d! i , for any dz 2 RL 1 . Consider any perturbation d! i such that
L
d! i1 + pd! i 1 = 0; for d! i 1 = (! il )l=2 : Any such perturbation, leaves each
agent i 2 I demand unchanged and hence it implies D!i z(p; !)d! i = d! i 1 ,
for any arbitrary d! i 1 2 RL :

Proposition 18 The set of equilibrium prices of an economy ! 2 RLI


++ is a
smooth manifold (see Math Appendix) of dimension LI:

Proof. Dp z (p; !) has rank L 1, as shown in the proof of the previous


proposition. The Inverse function theorem - Global (see Math Appendix)
applied to z : RL++1 RLI
++ ! R
L 1
; directly implies that the set p 2 z 1 (0);
as a function of ! 2 RLI
++ , is a smooth manifold of dimension LI:
3.3. COMPETITIVE EQUILIBRIUM 25

3.3.3 Dierentiable approach: A rough primer


The dierential techniques exploited to study generic local uniqueness can
be expanded to provide a general characterization of competitive equilibria
as a manifold parametrized by endowments. This characterization implies an
existence result. We sketch some of the analysis, just to provide the reader
with the avor of the arguments.

Denition 19 The index i(p; !) of a price p 2 RL++1 such that z (p; !) = 0


is dened as
i(p; !) = ( 1)L 1 sign jDp z (p; !)j :
The index i(!) of an economy (! i )i2I is dened as
X
i(!) = i(p; !):
p:z(p;!)=0

Theorem 20 (Index) For any regular economy ! 2 RLI


++ , i(!) = 1:

Proof. The theorem is a deep mathematical result whose proof is clearly


beyond the scope of this class. Let it su ce to say that the proof relies
crucially on the boundary property of excess demand. Adventurous reader
might want to look at Mas Colell (1985), section 5,6, p. 201-15.

Corollary 21 Any regular economy ! has an odd number of equilibria. In


particular, any regular economy ! 2 RLI
++ has at least one equilibrium.

Corollary 22 Any economy ! 2 RLI ++ has at least one equilibrium price p 2


L 1
R++ :
Proof. By contradiction. Suppose there exist an economy ! 2 RLI ++ with
no equilibrium. Then, ! 2 RLI ++ is regular, by denition of regularity - a
contradiction with previous corollary.

The existence result is then a corollary of the Index theorem. It is useful


to study the simple case in which L = 2: In this case, then, z : R++ ! R.
The boundary properties of the excess demand z(p; !) imply that, for any
! 2 R2I
++ ;

z(p; !) ! +1 as p ! 0
z(p; !) ! L as p ! 1:
26 CHAPTER 3. ARROW-DEBREU EXCHANGE ECONOMIES

As a consequence, an equilibrium exists by continuity of z(p; !). Further-


more, suppose ! is regular, and let the prices pj such that z(p; !) = 0 be
ordered, so that pj < pj+1 ; j = 1; 2; :::: Then @z(p;!)
@p
jp=p1 < 0: Actually,
n < 0 for j odd
@z(p;!)
@p p=pj : As a consequence, i(!) = 1:
> 0for j even
We can also try and give more sense of the arguments, o of the proof
of the Index theorem, required for this approach to the existence question.
Let ! 2 RLI ++ be an arbitrary regular economy. Pick an economy ! 2 R++
0 LI
L 1
such that there exist a unique price p 2 R++ such that z(p) = 0; and
Dp z(p) has rank L 1: One such economy can always be constructed by
choosing ! 0 2 RLI
++ to be a Pareto optimal allocation. In fact, [we can show
that] generic regularity holds in the subset of economies with Pareto optimal
endowments. Let t! + (1 t)! 0 ; for 0 t 1; represent a 1-dimensional
subset of economies. Let Z(p; t) be the map Z : RL++1 [0; 1] ! RL 1 induced
by Z(p; t) = z(p; t! + (1 t)! 0 ) for given (!; ! 0 ): We say that Z(p; t) is an
homotopy, or that z(p; !) and z(p; ! 0 ) are homotopic to each other. [We
can show that] DZ(p; t) has rank L 1 in its domain. It follows from the
Corollary of the Inverse function theorem - Global (see Math Appendix) that
the set (p; t) 2 Z 1 (0); is a smooth manifold of dimension 1: [We can show
that] prices p can, without loss of generality, be restricted to a compact set
P such that Z 1 (0) \ P [0; 1] = ?:4 As a consequence Z 1 (0) is a compact
smooth manifold of dimension 1: By the Classication theorem (see Math
Appendix), Z 1 (0) is then homeomorphic to a countable set of segments
in R and of circles S.5 Regularity of Z 1 (0) at the boundary, t = 0 and
t = 1 and the property that Z 1 (0) \ P [0; 1] = ? imply that at least one
component of Z 1 (0) is homeomorphic to a line with boundary at t = 0 and
t = 1: It looks confusing, but its easier with a few gures.
The only possible representation of Z 1 (0) is then as in the following
gure. Therefore: an equilibrium price p 2 P exists, for any t 2 [0; 1];
and furthermore, for a full-measure Lebesgue subset of [0; 1] the number of
equilibria is odd.

4
This is a consequence of the boundary conditions of excess demand systems. In other
words, we could adopt the alternative normalization, restricting prices in the simplex ;
a compact set, and show that equilibrium prices are never on @ :
5
Along a component of Z 1 (0) (a line or a circle), a change in index occurs when the
manifold folds.