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Price Dynamics in an Exchange Economy

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  • Steven Gjerstad

Abstract

The pure exchange model is the foundation of the neoclassical theory of value, yet equilibrium predictions and models of price adjustment for this model remained untested prior to the experiment reported in this paper. With the exchange economy replicated several times, prices and allocations converge sharply to the competitive equilibrium in continuous double auction (CDA) trading. Convergence is evaluated by comparing the extent of price adjustment within each market replication (or trading period) to the extent of adjustment across trading periods: most observed price adjustment occurs within trading periods, so price adjustment data are evaluated with the Hahn process model (Hahn and Negishi [1962]), which is a disequilibrium model of within-period trades. Estimation demonstrates that the model is consistent with observed price paths within each period of the exchange economy. The model is augmented with an additional assumption – based on observations from this experiment – that the initial trade price in period t+1 is randomly drawn from the interval between the minimum and maximum trade prices in period t. The estimated within-period adjustment rule, combined with this across-period adjustment rule, generates price paths similar to data from an experiment session.

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Bibliographic Info

Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1205.

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Length: 33 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:pur:prukra:1205

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Keywords: Competitive equilibrium; disequilibrium dynamics; continuous double auction; experimental economics; exchange economy; Hahn process; neoclassical theory of value; tatonnement; unit root tests;

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References

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  1. Anderson, Christopher M. & Granat, Sander & Plott, Charles R. & Shimomura, Ken-Ichi, 2000. "Global Instability in Experimental General Equilibrium: The Scarf Example," Working Papers 1086, California Institute of Technology, Division of the Humanities and Social Sciences.
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  3. Smith, Vernon L, 1982. "Microeconomic Systems as an Experimental Science," American Economic Review, American Economic Association, vol. 72(5), pages 923-55, December.
  4. Steven Gjerstad & John Dickhaut, 2003. "Price Formation in Double Auctions," Microeconomics 0302001, EconWPA.
  5. Peng Lian & Charles R. Plott, 1998. "General equilibrium, markets, macroeconomics and money in a laboratory experimental environment," Economic Theory, Springer, vol. 12(1), pages 21-75.
  6. Easley, David & Ledyard, John., . "Theories of Price Formation and Exchange in Double Oral Auctions," Working Papers 611, California Institute of Technology, Division of the Humanities and Social Sciences.
  7. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
  8. Vernon L. Smith, 1962. "An Experimental Study of Competitive Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 70, pages 111.
  9. Smith, Vernon L, 1976. "Experimental Economics: Induced Value Theory," American Economic Review, American Economic Association, vol. 66(2), pages 274-79, May.
  10. Daniel Friedman, 1982. "Price Formation in Double Auction Markets," UCLA Economics Working Papers 278, UCLA Department of Economics.
  11. Taylor, Alan M, 2001. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," Econometrica, Econometric Society, vol. 69(2), pages 473-98, March.
  12. Peng Lian & Charles R. Plott, 1998. "General equilibrium, markets, macroeconomics and money in a laboratory experimental environment," Economic Theory, Springer, vol. 12(1), pages 123-146.
  13. Gjerstad, Steven, 2007. "The competitive market paradox," Journal of Economic Dynamics and Control, Elsevier, vol. 31(5), pages 1753-1780, May.
  14. Cox, James C, 1997. "On Testing the Utility Hypothesis," Economic Journal, Royal Economic Society, vol. 107(443), pages 1054-78, July.
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  16. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  17. Steven Gjerstad & Jason M. Shachat, 2007. "Individual Rationality and Market Efficiency," Purdue University Economics Working Papers 1204, Purdue University, Department of Economics.
  18. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, September.
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Cited by:
  1. Smith, Vernon L., 2010. "Theory and experiment: What are the questions?," Journal of Economic Behavior & Organization, Elsevier, vol. 73(1), pages 3-15, January.
  2. Foley, Duncan K., 2010. "What's wrong with the fundamental existence and welfare theorems?," Journal of Economic Behavior & Organization, Elsevier, vol. 75(2), pages 115-131, August.
  3. Sean Crockett & Ryan Oprea & Charles Plott, 2011. "Extreme Walrasian Dynamics: The Gale Example in the Lab," American Economic Review, American Economic Association, vol. 101(7), pages 3196-3220, December.

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