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equilibrium

General equilibrium: How does an

idealized private ownership

competitive economy works ?

l goods (indexed by j)

n individuals (households) (indexed by i)

K firms (or technologies) (indexed by k)

firm k’s technology: a production set Y

k

_

l

that is closed, irreversible, convex and satisfies

the possibility of inaction, impossibility of free

production, and free disposal.

All goods are private (rival and excludable).

They are privately owned.

i

j

> 0: quantity of good j initially owned by

household i

General equilibrium: How does an

idealized private ownership

competitive economy works ? (2)

1 >

i

k

> 0 : share of firm k owned by household

i

Each firm is entirely owned (¿

i

i

k

= 1 for all k)

X

i

_

l

+

: Consumption set of household i

(convex and closed)

i

: preferences of household i (reflexive,

complete, transitive, continous, locally non-

satiable and convex binary relation on X

i

).

General equilibrium: How does an

idealized private ownership

competitive economy works ? (3)

An economy c = (Y

k

,X

i

,

i

,

i

k

,

i

j

), i =1,…,n,

j =1,…,l and k = 1,…K.

Economic problem: finding an

allocation of the l goods accross the n

individuals.

Some allocations are feasible, some are

not.

A(c): the set of all allocations of goods

that are feasible for the economy c.

General equilibrium: How does an

idealized private ownership

competitive economy works ? (4)

A(c) is defined as follows:

)

`

¹

¹

´

¦

¬ + s = e - = e

¿ ¿ ¿

= = =

K

k

k

j

n

i

i

j

n

i

i

j

k k i i

j y x t s K k for Y y n i for X x

1 1 1

. . ,..., 1 : ,..., 1 e

In words, A(c) is the set of bundles of goods

that could be consumed in the economy given

its technological possibilities, and the initial

available resources (under the assumption that

these resources are publicly owned)

A nice geometrical depiction of the set of

feasible allocations: the Edgeworth box

Suppose Y

k

= {0

l

} for all k (nothing is

produced)

Then c is an exchange economy.

A(c) in this case can be defined by:

)

`

¹

¹

´

¦

¬ s = e

¿ ¿

= =

j x n i for X x

n

i

i

j

n

i

i

j

i i

1 1

: ,..., 1 e

If l = n=2, we can represent the bundles that

satisfy this weak inequality at equality on the

following diagram

The Edgeworth Box

Individual 1

individual 2

x

2

2

x

1

1

x

1

2

x

2

1

x

2

=

1

2

+

2

2

1

=

1

1

+

2

1

The Edgeworth Box

Individual 1

individual 2

2

1

x

Pareto efficiency

Some feasible allocations of goods

involve waste.

Some feasible allocations of goods do

not exhaust the existing possibilities

of mutual gains (called « win-win »

situations in ordinary language)

Some feasible allocations of goods

are not Pareto-efficient!

Pareto efficiency

Definition: an allocation x

i

j

A(c) (for i =

1,…,n and j = 1,…,l) is Pareto-efficient in A(c)

if, for any other allocation z

i

j

A(c), having z

h

x

h

for some individual h must imply that x

g

z

g

i = 1,…,n. some individual g.

In words, an allocation x

i

j

A(c) (for i =

1,…,n and j = 1,…,l) is Pareto-efficient in A(c)

if it is impossible to find an allocation in

A(c) that everybody weakly prefers to x

i

j

and

that at least one person strictly prefers to x

i

j

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

z

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

z

2

1

z is not

Pareto-

efficient

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

Allocations in

this zone are

unanimously

preferred to z

z

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

Allocation y

(among other)

is unanimously

preferred to z

z

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

Allocation y

is Pareto-

efficient

z

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

So is x !

z

Pareto-efficiency in an Edgeworth Box

1

2

x

2

2

x

1

1

x

1

2

x

2

1

x

y

2

1

So are all the

allocations on

the blue locus

z

Pareto efficiency

A minimal normative requirement.

An inefficient allocation is unstatisfactory.

Yet Pareto-efficiency is hardly a sufficient

requirement.

There are many Pareto-efficient allocations,

and some of them may involve significant

inequality

As Amartya Sen put it « a society may be

Pareto-efficient and perfectly disgusting!

General Competitive equilibrium

What happens when all households and all

firms take their decisions individually,

taking as given a prevailing set of prices ?

Given prices, each firm chooses a

production activity that maximizes its

profits.

GIven prices, each household chooses a

bundle of l goods that it most prefer.

Prices are such that these choices are

mutually consistent (supply equal demand

on all markets).

General Competitive equilibrium

Here is a formal definition.

A General Competitive Equilibrium (GCE) for

the economy c = (Y

k

,X

i

,

i

,

i

k

,

i

j

), i =1,…,n,

j =1,…,l and k = 1,…K is a list (p*,x

i

*,y

k

*)

with p*

l

+

, x

i

* X

i

for i =1,…,n, y

k

* Y

k

for k =1,…K such that:

) 1 ( ) ,..., , ,..., , ,..., (

) ,..., , ,..., , ,..., (

1 1

* *

1

*

1 1

* *

1

*

i

K

i i

l

i

l

i i i

i

K

i i

l

i

l

i i

p p B z z x

p p B x

u u e e

u u e e

e ¬

e

~

General Competitive equilibrium

Here is a formal definition.

A General Competitive Equilibrium (GCE) for

the economy c = (Y

k

,X

i

,

i

,

i

k

,

i

j

), i =1,…,n,

j =1,…,l and k = 1,…K is a list (p*,x

i

*,y

k

*)

with p*

l

+

, x

i

* X

i

for i =1,…,n, y

k

* Y

k

for k =1,…K such that:

) 2 (

1

*

1

* * k

l

j

j j

l

j

k

j j

Y y y p y p e ¬ >

¿ ¿

= =

General Competitive equilibrium

Here is a formal definition.

A General Competitive Equilibrium (GCE) for

the economy c = (Y

k

,X

i

,

i

,

i

k

,

i

j

), i =1,…,n,

j =1,…,l and k = 1,…K is a list (p*,x

i

*,y

k

*)

with p*

l

+

, x

i

* X

i

for i =1,…,n, y

k

* Y

k

for k =1,…K such that:

) 2 (

1

*

1

* * k

l

j

j

k

j

l

j

k

j

k

j

Y y y p y p e ¬ >

¿ ¿

= =

and

General Competitive equilibrium

Here is a formal definition.

A General Competitive Equilibrium (GCE) for

the economy c = (Y

k

,X

i

,

i

,

i

k

,

i

j

), i =1,…,n,

j =1,…,l and k = 1,…K is a list (p*,x

i

*,y

k

*)

with p*

l

+

, x

i

* X

i

for i =1,…,n, y

k

* Y

k

for k =1,…K such that:

) 3 (

1 1

*

1

*

j y x

n

i

K

k

k

j

i

j

n

i

i

j

¬ + s

¿ ¿ ¿

= = =

e

General Competitive equilibrium

Condition 1) says that given prices, and the budget

constraint that these prices define (given initial

endowments and ownerships of firms), household i

chooses a bundle of goods that it most prefer in its

budget set.

Condition 2 says that given prices firm k chooses a

production activity in its production set that

maximizes its profits.

Condition 3 says that choices made by firms and

consumers are all mutually consistent (on every

market, the demand for the good is never superior

to the amount of good availabe (both as the result

of production and initial endowments). prices, each

household chooses a bundle of l goods that it most

prefer.

General-equilibrium in an Edgeworth

Box (no production)

1

2

1

2

1

1

2

1

2

2

General-equilibrium in an Edgeworth

Box (no production)

1

2

1

2

1

1

2

1

2

2

General-equilibrium in an Edgeworth

Box (no production)

1

2

x

2

2

x

1

1

1

2

1

1

2

1

2

2

-p

*

1

/p

*

2

(p

*

1

1

1

+

p

*

2

1

2

)/p

*

2

General-equilibrium in an Edgeworth

Box (no production)

1

2

x

2

2

x

1

1

1

2

1

1

2

1

2

2

-p

*

1

/p

*

2

(p

*

1

1

1

+

p

*

2

1

2

)/p

*

2

General-equilibrium in an Edgeworth

Box (no production)

1

2

x

2

2

x

1

1

1

2

1

1

2

1

2

2

-p

*

1

/p

*

2

(p

*

1

1

1

+

p

*

2

1

2

)/p

*

2

x

2*

1

x

1*

1

General-equilibrium in an Edgeworth

Box (no production)

1

2

x

2

2

x

1

1

1

2

1

1

2

1

2

2

-p

*

1

/p

*

2

(p

*

1

1

1

+

p

*

2

1

2

)/p

*

2

x

2*

1

x

1*

1

x

1*

2

x

2*

2

Excess demand correspondance

Condition 3 defines what is called the

« excess demand correspondance »

Z:

l

+

÷

l

. as follows:

j p y p x p Z

n

i

K

k

k

j

i

j

n

i

Mi

j j

¬ ÷ ÷ =

¿ ¿ ¿

= = = 1 1

*

1

) ( ) ( ) ( e

Where x

j

Mi

(p) is the Marshallian demand of good j by

household i at prices p and y

j

k*

(p) is the net supply of

good j by the firm k at prices p

Walras Law

Theorem: if consumers preferences satisfy

local non-satiation, then:

¿

=

=

l

j

l j j

p p Z p

1

1

0 ) ,..., (

Proof: see blackboard

A corrolary of Walras Law

Theorem: if an excess demand

correspondance Z satisfies Walras law and

if Z

j

(p) s 0 for all goods j, then p

g

= 0 for any

good g for which Z

g

(p) < 0.

Proof: obvious (see blackboard)

Interpretation: if the market for a good is in strict

excess supply at a CGE, then the price of this

good must be zero (example: sand, stones, etc.)

Consequence of this corrolary

If (p*,x

i

*,y

k

*) is CGE for an economy, then for

every good g for which p

g

> 0 one must have Z

g

(p)

= 0.

We are going to use this to prove the existence of

CGE for any economy satisfying our assumptions.

Establishing the existence of CGE has been one of

the major achievement of the 20th century

mathematical economics (finalized in fifeties

through the work of Arrow and Debreu.

Argument is based on the fact that certain

functions admit Fixed Points.

Fixed points

Many existence theorems in mathematical economics

and game theory (Nash equilibrium, GCE, etc.) are

consequences of mathematical theorems known as

« fixed point » theorems.

Two such theorems are particularly useful: Brouwer’s

fixed point theorem (that deals with functions) and

Kakutani’s fixed point theorem that deals with

correspondances.

In order to understand these theorems, we must first

understand what is a fixed point.

Definition: Given a function f: A ÷ A , we say of an

element a A that it is fixed point of f if f(a) =a

Some functions do not admit fixed points.

For example, the function f that assigns to every alive

individual whose father is alive this father does not

have fixed point (because nobody is his or her own

father)

Brouwer’s fixed point theorem

The mathematician Brouwer a

established (in 1912) a theorem

guaranteeing that a (real-valued) function

admits a fixed point.

Brouwer’s fixed point Theorem: Let A be

a subset convex and compact of

k

and

let f: A ÷ A be a continuous function.

Then, there exists an element a A that

is a fixed point of f

Let us illustrate the theorem when A is a

convex and compact subset (and

therefore an interval) of .

Brouwer fixed point theorem

A

A

x

y

y = x

f

Brouwer fixed point theorem

A

A

x

y

y = x

Fixed points

f

Brouwer fixed point Theorem

A

A

x

y

f

The assumptions of

Brouwer’s theorem

are all important

Brouwer fixed point theorem

A

A

x

y

f

For example the

function f

does not have

any fixed point

Brouwer fixed point theorem

A

A

x

y

f

but f

is not a function

from A to A

Brouwer fixed point theorem

A

A

x

y

f

This function f

(that is not continuous)

does not have fixed

point either!

Brouwer fixed point theorem

A

A

x

y

f

Similarly, if A is

open above a

continuous function like

f does not have

fixed points

Fixed points

Brouwer’s fixed point theorem applies to functions. Yet

the CGE can be viewed as the fixed point of a

correspondance of price adjustment (based on excess

demand).

Kakutani (1941) has generalized Brouwer’s fixed point

theorem to correspondances.

Kakutani fixed point theorem: Let A be a convex and

compact subset of

l

and let C: A ÷ A be

correspondance upper-semi continuous. Then, there

exists an element a* A that is a fixed point of C (and

that is therefore such that a* C(a*)).

John Nash in 1950 has used this theorem to show the

existence of a Nash equilibrium in non-cooperative

games.

Debreu (1959) has used it as well in his proof of the

existence of CGE.

Upper Semi-continuity ?

A

A

x

y

C

The correspondence

C is upper

semi-continuous

Upper semi-continuity ?

A

A

x

y

C

The correspondence

C is upper

semi-continuous

Upper semi-continuity ?

A

A

x

y

C

The correspondence

C is not

Upper semi-continuous

Berge (1959) Maximum Theorem

Theorem: Let A and B be two subsets of

k

with A compact and let u: A×B÷ be

a continuous function. Then, the

correspondence C: B ÷ A defined by:

) , ( max arg ) ( b a b C

a

u =

is upper semi continuous

Applies Berge Maximum Theorem (1)

To the profit maximization program.

¿

=

e

=

l

j

j j

Y y y

l

y p p p y

k

k

1

) ,..., (

1

*

1

max arg ) ,..., (

Here, set A of the theorem is the production set Y

k

Problem: Y

k

is not compact (it is closed but

possibly unbounded).

Solution: Maximize profits on the set Y

k

· {y

l

: y > -

} \

l

- -

(exclude plans that use more inputs than

what is initially available and/or that uses input

without producing any output).

Applies Berge Maximum Theorem (2)

To the consumer’s utility maximization

program:

) ,..., ( max arg ) ,..., (

1

) ,..., ,. ,..., , ,..., ( ) ,..., (

1

1 1 1 1

l

i

p p B x x

l

M

x x U p p X

i

k

i i

l

i

l l

u u e e e

=

Here, set A of the theorem is the budget set (that is

compact)

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