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The probability approach to general equilibrium with production

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  • Michael Magill

    ()

  • Martine Quinzii

    ()

Abstract

We develop an alternative approach to the general equilibrium analysis of a stochastic production economy when firms’ choices of investment influence the probability distributions of their output. Using a normative approach we derive the criterion that a firm should maximize to obtain a Pareto optimal equilibrium: the criterion expresses the firm’s contribution to the expected social utility of output, and is not the linear criterion of market value. If firms do not know agents utility functions, and are restricted to using the information conveyed by prices then they can construct an approximate criterion which leads to a second-best choice of investment which, in examples, is found to be close to the first best.

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File URL: http://hdl.handle.net/10.1007/s00199-008-0336-x
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 39 (2009)
Issue (Month): 1 (April)
Pages: 1-41

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Handle: RePEc:spr:joecth:v:39:y:2009:i:1:p:1-41

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Related research

Keywords: Optimal investment; Probability distribution of output; Equilibrium; D21; D51;

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References

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  1. Prescott, Edward C & Townsend, Robert M, 1984. "General Competitive Analysis in an Economy with Private Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 1-20, February.
  2. Edward C Prescott & Robert M Townsend, 2010. "Pareto Optima and Competitive Equilibria With Adverse Selection and Moral Hazard," Levine's Working Paper Archive 2069, David K. Levine.
  3. Geanakoplos, J. & Magill, M. & Quinzii, M. & Dreze, J., . "Generic inefficiency of stock market equilibrium when markets are incomplete," CORE Discussion Papers RP -916, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
  5. Ehrlich, Isaac & Becker, Gary S, 1972. "Market Insurance, Self-Insurance, and Self-Protection," Journal of Political Economy, University of Chicago Press, vol. 80(4), pages 623-48, July-Aug..
  6. Kocherlakota, Narayana R., 1998. "The effects of moral hazard on asset prices when financial markets are complete," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 39-56, February.
  7. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  8. William R. Zame, 2007. "Incentives, Contracts, and Markets: A General Equilibrium Theory of Firms," Econometrica, Econometric Society, vol. 75(5), pages 1453-1500, 09.
  9. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
  10. Radner, Roy, 1972. "Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, Econometric Society, vol. 40(2), pages 289-303, March.
  11. Marcos B. Lisboa, 2001. "Moral hazard and general equilibrium in large economies," Economic Theory, Springer, vol. 18(3), pages 555-575.
  12. Marshall, John M, 1976. "Moral Hazard," American Economic Review, American Economic Association, vol. 66(5), pages 880-90, December.
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Citations

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Cited by:
  1. Jakub Growiec & Lukasz Wozny, 2010. "Intergenerational interactions in human capital accumulation," National Bank of Poland Working Papers 71, National Bank of Poland, Economic Institute.
  2. Magill, Michael & Quinzii, Martine, 2014. "Anchoring expectations of inflation," Journal of Mathematical Economics, Elsevier, vol. 50(C), pages 86-105.
  3. Balbus, Łukasz & Reffett, Kevin & Woźny, Łukasz, 2012. "Stationary Markovian equilibrium in altruistic stochastic OLG models with limited commitment," Journal of Mathematical Economics, Elsevier, vol. 48(2), pages 115-132.

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