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Predetermined Prices and the Allocation of Social Risks

  • Costas Azariadis
  • Russell Cooper

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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File URL: http://cowles.econ.yale.edu/P/cd/d06b/d0660.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 660.

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Length: 35 pages
Date of creation: 1983
Date of revision:
Publication status: Published in Quarterly Journal of Economics (May 1985), 495-518
Handle: RePEc:cwl:cwldpp:660
Note: CFP 613.
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  1. 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.
  2. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
  3. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  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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