Discussion paper no. 01-11
Small Income Effects Destroy the Constrained Efficiency of All Equilibria in Finance Economies with Production
Egbert Dierker & Hildegard Dierker and Birgit Grodal
ABSTRACT: We consider economies with incomplete markets, one good per state, private ownership of initial endowments, a single firm, and no assets other than shares in this firm. In this simple framework, arbitrarily small income effects can render every market equilibrium resulting from some production decision constrained inefficient. Thus, even if all utility functions are approximately quasilinear, the stock market can be unable to achieve a constrained efficient allocation given the agents' characteristics. Moreover, the phenomenon persists when the efficiency requirements are substantially weakened. PDF
Keywords: incomplete markets with production, constrained efficiency, Drèze equilibria
JEL Classification: D2, D52, D61, G1