Stabilizing the economy: Market design and general equilibrium
AbstractWe employ laboratory methods to study stability of competitive equilibrium in Scarf's economy (International Economic Review, 1960). Tatonnement theory predicts that prices are globally unstable for this economy, i.e. unless prices start at the competitive equilibrium they oscillate without converging. Anderson et al. (Journal of Economic Theory, 2004) report that in laboratory double auction markets, prices in the Scarf economy do indeed oscillate with no clear sign of convergence. We replicate their experiments and confirm that tatonnement theory predicts the direction of price changes remarkably well. Prices are globally unstable with adverse effects for the economy's efficiency and the equitable distribution of the gains from trade. We also introduce a novel market mechanism where participants submit demand schedules and prices are computed using Smale's global Newtonian dynamic (American Economic Review, 1976). We show that for the Scarf economy, submitting a competitive schedule, i.e. a set of quantities that maximize utility taking prices as given, is a weakly dominant strategy. The resulting outcome corresponds to the unique competitive equilibrium of the Scarf economy. In experiments that employ the schedule market, prices do not oscillate but instead converge quickly to the competitive equilibrium. Besides stabilizing prices, the schedule market is more efficient and results in highly egalitarian outcomes.
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Bibliographic InfoPaper provided by Department of Economics - University of Zurich in its series ECON - Working Papers with number 092.
Date of creation: Sep 2012
Date of revision:
Scarf economy; tatonnement; global Newtonian dynamic; instability; general equilibrium; market design;
Find related papers by JEL classification:
- C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
- D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-22 (All new papers)
- NEP-EXP-2012-09-22 (Experimental Economics)
- NEP-HPE-2012-09-22 (History & Philosophy of Economics)
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