General Equilibrium in an Imperfect World: Incomplete Markets

Abstract

General equilibrium theory is an intellectual achievement of the first rank. It answers a purely logical question: can a decentralised economy of rational and greedy agents whose actions are guided only by prices be coherent? The economy is in a coherent state when all intended actions are mutually compatible. We know that under certain postulates the answer to this question is ‘yes’. This answer does not entail the conclusion that, even given the postulates, actual economies are always in a coherent state. Nor, of course, are all the required postulates descriptively adequate. For instance a pure Ar-row-Debreu economy cannot accommodate an intrinsically worthless means of exchange. No version of the theory seems to be able to account for advertising or to give a satisfactory analysis of innovations. One can of course go on. For a serious economist two things are clear: general equilibrium theory in its canonical form can only be regarded as a starting-point of an eventually descriptively satisfactory theory and it is an important part of our armoury nonetheless.