Market Design and the Stability of General Equilibrium
Journal of Economic Theory
This is the author accepted manuscript. The final version is available from Elsevier via the DOI in this record.
Reason for embargo
We employ laboratory methods to study the 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 is the unique competitive equilibrium of the Scarf economy. In experiments using the schedule market, prices converge quickly to the competitive equilibrium. Besides stabilizing prices, the schedule market is more efficient and results in highly egalitarian outcomes.
We would like to thank the Swiss National Science Foundation (SNSF 138162) and the European Research Council (ERC Advanced Investigator Grant, ESEI-249433) for financial support. We are grateful for useful suggestions we received from seminar participants at University of Nottingham and the ESA meeting in New York
Journal of Economic Theory, 2016, Volume 165, pp.37-68