CALIFORNIA INSTITUTE OF TECHNOLOGY

Division of the Humanities and Social Sciences

Brief Notes on the ArrowDebreuMcKenzie Model of an Economy

KC Border
January 2000 v. 2012.08.28::12.50

Commodities

The rst primitive concept is that of a commodity. A commodity is any good or service that may be produced, consumed, or traded. Commodities may distinguished by date, location, and state of the world. For mathematical simplicity we usually assume there is a nite number of commodities. The commodity space is thus R .

Tastes

The next concept is that of an idealized consumer or household. A consumer is partially described by a consumption set X, which is a subset of the commodity space. Elements x of X are ordered lists of quantities of commodities consumed. If xk < 0 it indicates that commodity k is a labor service being supplied. The other part of the description of a consumer is the consumers preference relation on X, which is generally assumed to be transitive, total, and reexive. The relation x y is read x is at least as good as y. The strict preference relation is dened by xy if x y but not y x,

and indierence is dened by xy if x y and y x.

The set {y X : y x} is the indierence class of x or the indierence curve through x. The set {y X : y x} is the upper contour set at x, and {y X : y x} is the strict upper contour set at x. The relation y x means x y, etc. 1

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ArrowDebreuMcKenzie Model

In general there may be m consumers. We may make use of the following assumptions. Conditions on consumption sets. 1. Each Xi is closed. 2. Each Xi is convex. 3. Each Xi is bounded below. Conditions on preferences. 1. Each i is nonsatiated. 2. Each i is continuous. 3. Preferences are convex. That is, if x i y, then for every (0, 1) we have x + (1 )y i y (provided x + (1 )y Xi ).1

Technology

The next concept is that of a production unit or enterprise which is characterized by its technology set Y . For y belonging to Y , yk < 0 indicates that commodity k is used as an input and yk > 0 indicates that it is an output. In general there may be n enterprises. Conditions on production. 1. There is a possibility of inaction. That is, 0 Yj for each j. 2. The aggregate production set Y = n Yj is closed. (Note that each j=1 Y j may be closed without Y being closed.) 3. The aggregate production set Y =
n
j=1 Yj

is convex.

4. Production is irreversible. That is, Y (Y ) {0}. 5. There is free disposability. That is, if y Y , then {y} R Y .2 +
The provision is explicit so that violations of condition 2 do not imply a violation of 3. This condition is usually written as R Y . My formulation makes it easier + to construct economies satisfying free disposability and irreversibility, yet violating the possibility of inaction.
2 1

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Resources

The third element in the description of an economy is the aggregate endowment R . We typically assume 0, but that is mainly a denition of what it means to be a resource.

Allocations
E = (Xi , i )m , (Yj )n , . i=1 j=1 An allocation for the economy E is a list (x1 , . . . , xm , y 1 , . . . , y n )
( )

An economy is thus summarized by a list

satisfying xi Xi y j Yj
m i=1

i = 1, . . . , m j = 1, . . . , n
n j=1

xi = +

yj .

A natural question is whether allocations exist at all. Let X = m X i . i=1 The question is whether X (Y + ) = . There are a couple of ways to guarantee this. One is to assume 0 Y j (possibility of inaction) for each producer and that each consumer satises i X i . Then ( 1 , . . . , m , 0, . . . , 0) is an allocation. If we dont wish to assume i X i , we might assume the existence of xi X i with xi i , and assume that Y exhibits free disposability. (There are other reasons we may make this assumption. Do you see why it guarantees the existence of allocations?)

Eciency

An allocation (1 , . . . , xm , y 1 , . . . , y n ) is inecient3 if there is some other x 1 , . . . , xm , y 1 , . . . , y n ) such that allocation (x xi i xi

3

for all i,

Or Pareto dominated

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and xi i xi for at least one i. An allocation is ecient4 if it is not inecient.

Private property

In an economy with the social convention of private property, the aggregate endowment and all the enterprises are wholly owned by the consumers. To completely describe such an economy and its property system A private ( ) i ownership economy E is a list (Xi , i , i )m , (Yj )n , (j )i=1,...,m . Here i=1 j=1 j=1,...,n i is a list of consumer is initial private endowment of each commodity, so m =
i j

i=1

i,

and is the share of rm j owned by consumer i. These shares are nonnegative and sum to unity:
i j 0, for all i, j,

and

m i=1

i j = 1 for all j.

Walrasian equilibrium

The outcome of competitive markets in a private ownership economy is modeled as a Walrasian equilibrium, which is an allocation together with a price system that is characterized by three properties. 1. Each rm maximizes prots, taking prices as given. 2. Each consumer maximizes preferences subject to their budget constraint. 3. All markets clear. Due to our sign conventions on inputs and outputs, the prot generated by the input-output plan y at price vector p is p y. So formally a Walrasian equilibrium is a list (1 , . . . , xm , y 1 , . . . , y n , p), x where
4

Or Pareto ecient or Pareto optimal

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1. (Prot Maximization) For every rm j, y j Yj and p y j p y j for all y j Y j .

2. (Preference Maximization) For every consumer i, xi Bi = {xi Xi : pxi p i +

n i j pj } and y

xi i xi for all xi Bi .

j=1

3. (Market clearing) (1 , . . . , xm , y 1 , . . . , y n ) is an allocation, that is, x

m i=1

xi =

m i=1

i +

n j=1

yj .

8.1

Walrasian quasiequilibrium

A closely related concept is that of a Walrasian quasiequilibrium, in which the preference maximization property is replaced by an expenditure minimization property. 2 . (Expenditure minimization) For every consumer i, p xi p xi for all xi satisfying xi xi .

Suggested references
[1] C. D. Aliprantis, D. J. Brown, and O. Burkinshaw. 1989. Existence and optimality of competitive equilibria. New York: SpringerVerlag. [2] K. J. Arrow and G. Debreu. 1954. Existence of an equilibrium for a competitive economy. Econometrica 22(3):265290. www.jstor.org/stable/1907353 [3] K. J. Arrow and F. H. Hahn. 1971. General competitive analysis. San Francisco: HoldenDay. [4] G. Debreu. 1956. Market equilibrium. Proceedings of the National Academy of Sciences, U.S.A. 42(11):876878. www.pnas.org/cgi/reprint/42/11/876 [5] . 1959. Theory of value: An axiomatic analysis of economic equilibrium. Number 17 in Cowles Foundation Monographs. New Haven: Yale University Press. cowles.econ.yale.edu/P/cm/m17/m17-all.pdf
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[6]

. 1962. New concepts and techniques for equilibrium analysis. International Economic Review 3(3):257273. www.jstor.org/stable/2525394

[7] B. Ellickson. 1993. Competitive equilibrium: Theory and applications. Cambridge and New York: Cambridge University Press. [8] T. C. Koopmans. 1957. Three essays on the state of economic science. New York: McGraw-Hill. [9] L. W. McKenzie. 1955. Competitive equilibrium with dependent consumer preferences. In H. A. Antosiewicz, ed., Proceedings of the Second Symposium in Linear Programming, pages 277294, Washington, D.C. National Bureau of Standards and Directorate of Management Analysis, DCS/Comptroller, USAF. [10] [11] [12] . 1959. On the existence of general equilibrium for a competitive market. Econometrica 27:5471. www.jstor.org/stable/1907777 . 1961. On the existence of general equilibrium: Some correcwww.jstor.org/stable/1909294 tions. Econometrica 29(2):247248. . 1981. The classical theorem on existence of competitive equilibrium. Econometrica 49:819841. www.jstor.org/stable/1912505

[13] T. Negishi. 1960. Welfare economics and existence of an equilibrium for a competitive economy. Metroeconomica 12(23):9297. DOI: 10.1111/j.1467-999X.1960.tb00275.x [14] H. Nikaid. 1956. On the classical multilateral exchange problem. Metroeconomica 8(2):135145. DOI: 10.1111/j.1467-999X.1956.tb00097.x [15] J. P. Quirk and R. Saposnik. 1968. Introduction to general equilibrium theory and welfare economics. New York: McGrawHill.

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