CeDEx workshop - Luke Lindsay (University of Zurich)

Stabilising the Economy: Market Design and General Equilibrium

We study the stability of competitive equilibrium in Scarf’s (Int.Econ. Rev. 1 (1960) 157) economy in the laboratory under two market mechanisms. In this economy, Tatonnement theory predicts prices will be globally unstable. That is, unless prices start at the competitive equilibrium, prices will oscillate without converging to equilibrium. This prediction follows from the simple assumption that the price of a commodity increases if demand for the commodity exceeds supply and that the rate of change of the price is proportional to the excess demand.   Anderson et al (J. Econ. Theory 115 (2004) 209) have found that in laboratory double auctions, prices in Scarf’s economy do indeed oscillate. We replicate these experiments and find Tatonnement theory predicts the direction of price changes remarkably well. Then we test a novel market mechanism where participants submit demand schedules. Using this new mechanism, instead of oscillating prices quickly converge to the competitive equilibrium. Furthermore, efficiency is significantly higher: 95 percent of the potential gains from trade are realised compared to 77 percent under the double auction.