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Predetermined Prices and the Allocation of Social Risks

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  • Azariadis, Costas
  • Cooper, Russell

Abstract

We propose a Walrasian explanation for the existence of fixed prices, i.e., of trades in which either the price or the quantity exchanged do not reflect all publicly available information. Such trades result in a rigid price system that facilitates the sharing of social risks; they may also cause allocative distortions which tend to increase the equilibrium price of insurance above its actuarially fair level. The simple overlapping generations model we consider here exhibits a tradeoff between risk sharing and allocative efficiency that is familiar from the incentives literature. We demonstrate that the market for non-contingent claims is active only when the insurance "gain" from it outweighs the "cost" of allocative distortions. Fixed price equilibria are constrained optima in this essay, i.e., they cannot be dominated by an appropriately constrained central planner.

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Bibliographic Info

Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 100 (1985)
Issue (Month): 2 (May)
Pages: 495-518

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Handle: RePEc:tpr:qjecon:v:100:y:1985:i:2:p:495-518

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  1. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  2. Shell, Karl, 1971. "Notes on the Economics of Infinity," Journal of Political Economy, University of Chicago Press, vol. 79(5), pages 1002-11, Sept.-Oct.
  3. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
  4. Grossman, Sanford J., 1977. "A characterization of the optimality of equilibrium in incomplete markets," Journal of Economic Theory, Elsevier, vol. 15(1), pages 1-15, June.
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Cited by:
  1. Scott Freeman & Guido Tabellini, 1991. "The Optimality of Nominal Contracts," NBER Technical Working Papers 0110, National Bureau of Economic Research, Inc.
  2. Antoine Martin & Cyril Monnet, 2001. "When should labor contracts be nominal?," Research Working Paper RWP 01-07, Federal Reserve Bank of Kansas City.
  3. Alexander L. Wolman, 2000. "The frequency and costs of individual price adjustments," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-22.
  4. Jovanovic, Boyan & Ueda, Masako, 1998. "Stock-Returns and Inflation in a Principal-Agent Economy," Journal of Economic Theory, Elsevier, vol. 82(1), pages 223-247, September.
  5. Russell Cooper, 1984. "Insurance, Flexibility and Non-contingent Trades," Cowles Foundation Discussion Papers 691, Cowles Foundation for Research in Economics, Yale University.

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