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The Probability Approach To General Equilibrium With Production

  • Martine Quinzii
  • Michael Magill

    (Department of Economics, University of California Davis)

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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Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 83.

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Length: 44
Date of creation: 01 Dec 2007
Date of revision:
Handle: RePEc:cda:wpaper:08-3
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  1. Geanakoplos, J. & Magill, M. & Quinzii, M. & Dreze, J., 1990. "Generic inefficiency of stock market equilibrium when markets are incomplete," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 113-151.
  2. 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.
  3. William R. Zame, 2005. "Incentives, Contracts And Markets: A General Equilibrium Theory Of Firms," UCLA Economics Working Papers 843, UCLA Department of Economics.
  4. 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.
  5. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  6. 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.
  7. Marshall, John M, 1976. "Moral Hazard," American Economic Review, American Economic Association, vol. 66(5), pages 880-90, December.
  8. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
  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. 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.
  11. 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..
  12. Marcos B. Lisboa, 2001. "Moral hazard and general equilibrium in large economies," Economic Theory, Springer, vol. 18(3), pages 555-575.
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