General competitive

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 ks 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:

)
`

+ 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:
)
`

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

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

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

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

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

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

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

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

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: Brouwers
fixed point theorem (that deals with functions) and
Kakutanis 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)
Brouwers fixed point theorem
The mathematician Brouwer a
established (in 1912) a theorem
guaranteeing that a (real-valued) function
admits a fixed point.
Brouwers 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
Brouwers 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
Brouwers 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 Brouwers 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: AB 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 consumers 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)