Sunspot Equilibrium

Abstract

How does one explain the randomness which we see in the economy? Part of it can be traced to the randomness in the physical world which is transmitted through the economic fundamentals (such as endowments, technology and preferences). The weather provides an example. The randomness in rainfall causes randomness in crop yields which in turn generates randomness in agricultural outputs and agricultural prices. Since rainfall affects the economic fundamental (in particular, it affects agricultural technology), it is said to be an intrinsic variable. Hence, uncertainty about rainfall is also an example of intrinsic uncertainty (see Cass and Shell, 1983, p. 194). The classic Arrow—Debreu extension of the general-equilibrium model to include uncertainty has long been the basis for analysing intrinsic uncertainty (see, e.g., Debreu, 1959, ch. 7).