Inefficiency of equilibria with incomplete markets

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    Abstract

    As is well known, equilibria with incomplete markets are generically Pareto inefficient. In this paper, we demonstrate the leading role of a budget constraint in the occurrence of Pareto inefficiency of equilibria with incomplete markets. Specifically, on the basis of the classical two-period one-good pure exchange model we prove that so long as a budget constraint is met for all agents, equilibria with incomplete markets are generically Pareto inefficient in initial endowments and utility functions regardless of the optimization behavior of each agent. All we require of utility functions is a very weak hypothesis called current monotonicity. A simple unified method applicable to both a real asset case and a nominal asset case is presented, so that our claim is proved in both cases.

    Original languageEnglish
    Pages (from-to)887-897
    Number of pages11
    JournalJournal of Mathematical Economics
    Volume41
    Issue number7
    DOIs
    Publication statusPublished - 2005 Nov

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    Keywords

    • Budget optimum
    • Current monotonicity
    • Incomplete market

    ASJC Scopus subject areas

    • Economics and Econometrics
    • Applied Mathematics

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