HANDBOOK OF MATHEMATICAL

VOLUME II

Edited by

KENNETH J. ARROW Stanford University and MICHAEL D. INTRILIGATOR University of California, Los Angeles

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1982 NORTH-HOLLAND PUBLISHING COMPANY AMSTERDAM * NEW YORK • OXFORD CONTENTS OF VOLUME II

Introduction to the Series v Contents of the Handbook vii Preface to the Handbook xi

Part 2 - MATHEMATICAL APPROACHES TO MICROECONOMIC THEORY 7

Chapter 9 Consumer Theory y\NTON P. BARTEN and VOLKER BOHM 381 1. Introduction 381 2. Commodities and 382 3. Consumers 383 4. Preferences 384 5. functions 388 6. Properties of preferences and of utility functions . 390 6.1. Monotonicity, non-satiation, and convexity 390 6.2. Separability 392 6.3. Smooth preferences and differentiable utility functions 394 7. Continuous demand 395 8. Demand without transitivity 397 9. Demand under separability 399 10. Expenditure functions and indirect utility functions 401 11. Properties of differentiable utility functions 403 12. Differentiable demand 409 13. Properties of first-order derivatives of demand functions 415 14. Separability and the Slutsky matrix 418 15. Additive utility and demand 423 References 427

Chapter 10 . Producers Theory M. ISHAQ NADIRI 431 0. Introduction _ 431 1. Production technology 432 1.1. Properties of the production technology set and production function 432 Contents of Volume II

1.2. Neoclassical 1.3. Scale, factor substitutions, and technical change: Some definitions 2. Properties of the production function and duality 2.1. Homogeneity, additivity, and separability 2.2. Duality of production technology and cost and functions 2.3. Applications of the duality principle: Profit and cost functions 3. Functional forms of the production function: Capital stock aggregation 3.1. Forms of the production function 3.2. Aggregate capital stock: The Cambridge-Cambridge controversy 4. Some extensions of the theory of the firm 4.1. Disequilibrium models of input demand 4.2. Behavior of the firm under regulatory constraints 4.3. and scope in the multi-product firm 5. Conclusions References Chapter 11 . Theory JAMES FRIEDMAN 1. Overview of oligopoly theory and summary of the chapter 2. The early history - single-period models 2.1. Cournot's homogeneous products quantity model and the Cournot equilibrium 2.2. Bertrand's critique of Cournot's contribution 2.3. Differentiated products with prices as the firms' decision variables - Chamberlin's modification 2.4. On cooperative versus non-cooperative equilibria 3. Stability and reaction functions - first steps toward multi-period models 3.1. Cournot's reaction curves and Bowley's conjectural variation 3.2. The explicit behavioral hypotheses of Sweezy and Stackelberg 4. Multi-period models 4.1. Lagged response reaction function models 4.2. Models with quick response or adjustment costs 4.3. A model yielding cooperative equilibria without a cartel 4.4. Models with a time-dependent structure 5. Oligopoly and 6. Entry and exit in oligopoly models 7. Bi-lateral _. 8. Oligopoly embedded into models of general equilibrium 8.1. The theory approach Contents of Volume II xv

8.2. Non-cooperative models 532 8.3. An impossibility theorem 532 References 533

Chapter 12 Duality Approaches to Microeconomic Theory W. E. DIEWERT 535 1. Introduction 535 2. Duality between cost (expenditure) and production (utility) functions: A simplified approach 537 3. Duality between cost and aggregator (production or utility functions) J 553 4. Duality between direct and indirect aggregator functions 556 5. Duality between direct aggregator functions and distance or deflation functions . 559 6. Other duality theorems 562 7. Cost minimization and the derived demand for inputs 566 8. The Slutsky conditions for consumer demand functions 570 9. Empirical applications using cost or indirect utility functions 573 10. Profit functions 580 11. Duality and non-competitive approaches to microeconomic theory 584 11.1. Approach 1: The monopoly problem ' 584 11.2. Approach 2: The problem 586 11.3. Approach 3: The monopoly approach revisited 587 11.4. Approach 4: The monopoly problem once again 588 11.5. Historical notes 590 12. Conclusion 590 References 591

Chapter U On the Microeconomic Theory of Investment under Uncertainty ROBERT C. MERTON 601 1. Introduction 601 2. One-period portfolio selection 602 3. Risk measures for securities and portfolios in the one-period model 614 4. Spanning, separation, and mutual fund theorems 619 5. Two special models of one-period portfolio selection 637 6. Investment theory for the firm 642 7. Intertemporal consumption and portfolio selection theory 651 References 666 xvi Contents of Volume II

Chapter 14 Demand and Excess Demand Functions WAYNE SHAFER and HUGO SONNENSCHEIN . 671 1. Introduction 671 - 2. Notation and preliminaries 672 3. When the market demand function is a consumer demand function •• 674 4. Market excess demand functions 679 5. Market demand functions 688 6. Applications 691 References y 692

Part 3 - MATHEMATICAL APPROACHES TO COMPETITIVE EQUILIBRIUM

Chapter 15 xistence of Competitive Equilibrium GERARD DEBREU 697 1. Introduction 697 2. The simultaneous optimization approach 698 3. The excess demand approach , 715 4. Economies with a measure space of agents 725 References 730

Chapter 16 Stability FRANK HAHN 745 0. Introduction 745 1. Technical preliminaries 747 2. Tatonnement 754 2.1. Local results 754 2.2. Global results 763 2.3. Discrete time 768 2.4. A tatonnement for the core: A digression 770 3. Trading out of equilibrium 772 3.1. Exchange without prices 772 3.2. Exchange with prices 777 4. Doing without the auctioneer 788 References 791 Contents of Volume II xvii

Chapter 17 Regular Economies EGBERT DIERKER 795 1. Introduction 795 2. Excess demand approach: Debreu's theorem 798 3. Excess demand approach: Some extensions 804 4. Structure of the equilibrium manifold 811 5. Large economies 815 6. Smale's approach 823 References 828

Chapter 18 / Core of an Economy WERNER HILDENBRAND 831 1. Introduction 831 2. Definitions: Economy and core 833 2.1. The core of an exchange economy 833 2.2. The core of a coalition production economy 837 Appendix: The space of preferences 839 3. Economies with a continuum of agents • 841 4. Core and prices of a large but finite economy 847 5. Replica economies 854 6. Competitive sequences of economies • 861 Appendix: Equilibrium distributions 867 7. Many agents are not enough 868 8. A limit theorem without convexity of preferences 873 References 875

Chapter 19 Temporary General Equilibrium Theory "JEAN-MICHEL GRANDMONT 879 1. Introduction 879 2. Individual decision making 882 2.1. General formulation 882 2.2. Preferences among actions 884 2.3. Properties of the decision rule 885 2.4. Bibliographical note 886 3. Temporary competitive equilibrium 887 3.1. Market equilibrium 887 3.2. Temporary competitive equilibrium in forward markets 888 3.3. Temporary competitive equilibrium and money 894 xviii , ' Contents of Volume II

3.4. Temporary competitive equilibrium and production 901 3.5. Bibliographical note 903 4. Temporary equilibrium with quantity 903 4.1. Market equilibrium with quantity rationing 905 4.2. Equilibrium with quantity rationing and macroeconomic theory 911 4.3. Bibliographical note 916 References . 917

Chapter 20 ^Equilibrium under Uncertainty ROY RADNER 923 1. Introduction / 923 1.1. Equilibrium and uncertainty 923 1.2. Plan of the chapter 924 1.3. Informal review of the Arrow-Debreu model of a complete market for present and future contingent delivery 925 1.4. Extension of the Arrow-Debreu model to the case in which different agents have different information 928 1.5. Choice of information 930 1.6. Critique of the extended Arrow-Debreu economy 930 1.7. Sequences of markets 931 2. Events, commodities, commitments, and prices 933 3. Market equilibrium 936 3.1. Temporary market equilibrium 936 3.2. The Arrow-Debreu model 938 3.3. Information and expectations 940 3.4. The extended Arrow-Debreu mode! 942 3.5. Private information, moral hazard, self-selection, and the incentive to reopen markets 948 3.6. An example of the approach: The Grandmont model of temporary equilibrium 949 4. Equilibrium of plans and expectations 955 4.1. Equilibrium in a sequence of markets with common information 955 4.2. Rational expectations equilibrium in a model with differential information 958 4.3. A robust example of non-existence of rational expectations equilibrium 967 4.4. Rational expectations equilibria in a stationary linear model 970 5. Production 972 5.1. Introduction 972 5.2. Production in the Arrow-Debreu model 973 5.3. Stock markets and optimal allocation in a two-period model with fixed production plans 974 5.4. Equilibrium of plans and expectations with production and stock markets 977 Contents of Volume II xix

5.5. Comments on the assumptions and on alternative formulations 979 6. Adjustment, stability, and stationary disequilibrium 981 6.1. Introduction 981 6.2. Stochastic adjustment without inventories 982 6.3. Stochastic adjustment with inventories 983 6.4.' Adjustment towards rational expectations equilibrium 986 7. Bibliographic notes 995 7.1. Notes to Section 1 995 7.2. Notes to Section 2 996 7.3. Notes to Section 3 996 7.4. Notes to Section 4 997 7.5. Notes to Section 5 / 998 7.6. Notes to Section 6 1000 References 1002

Chapter 21 The Computation of Equilibrium Prices: An Exposition HERBERT E. SCARF 1007 1. The general equilibrium model 1007 2. Brouwer's fixed point theorem 1013 3. An algorithm for computing fixed points 1015 4. The non-retraction theorem 1026 5. A specific subdivision • 1029 6. A numerical example 1037 7. Vector labels 1043 8. The general equilibrium model with production 1049 9. The algorithms of Merrill and Eaves 1054 References 1059 List of Theorems 1063

Index 1065