Chapter 30 Incomplete markets

Publisher Summary This chapter analyzes the GEI model of an exchange economy in which one finds that when markets are incomplete, changing the financial instruments, or when nominal assets are present, changing the money, supply leads to a change in the equilibrium allocation; in short, financial instruments and money are nonneutral. The chapter presents a systematic analysis of the concepts and mathematical techniques needed for a proper understanding of the behavior of GEI equilibria. While real assets are inflation proof, nominal assets are not. The economic consequence is the striking property exhibited by the GEI model with nominal assets: indeterminacy if the model is left unchanged and nonneutrality of money if a role is introduced for money as a medium of exchange. The chapter presents an analysis of the GEI model of a production economy: it is the theory that encounters great difficulties. When markets are incomplete each firm faces a public goods problem with respect to its constituency of shareholders (and employees) for which there is no evident solution. The chapter also presents a reasonably coherent view of the current status of the theory of incomplete markets.

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