Strategic Foundations of General Equilibrium: More Information

Cambridge University Press
0521643309 - Strategic Foundations of General Equilibrium: Dynamic Matching and

Bargaining Games
Douglas Gale
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Strategic Foundations of General Equilibrium

Dynamic Matching and Bargaining Games
The theory of competition has held a central place in economic

analysis since Adam Smith. This book, written by one of the
most distinguished of contemporary economic theorists, reports
on a major research program to provide strategic foundations for
the theory of perfect competition.
Beginning with a concise survey of how the theory of compe-
tition has evolved, Gale makes extensive and rigorous use of
dynamic matching and bargaining models to provide a more
complete description of how a competitive equilibrium is
achieved. Whereas economists have made use of a macroscopic
description of markets in which certain behavioral characteris-
tics, such as price-taking behavior, are taken for granted, Gale
uses game theory to re-evaluate this assumption, beginning
with individual agents and modeling their strategic interaction.
A strategic foundation for competitive equilibrium shows how
such interaction leads to competitive, price-taking behavior.
DOUGLAS G A L E is Professor of Economics in New York

University. A Fellow of the Econometric Society, he has served
as assistant editor of Review of Economic Studies and co-editor
of Econometrica. He is currently associate editor of Journal of
Economic Theory, Research in Economics and Economic
Theory and advisory editor of Macroeconomic Dynamics. His
research papers have been published in leading journals.
© Cambridge University Press www.cambridge.org

Bargaining Games
Douglas Gale
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CHURCHILL LECTURES IN ECONOMIC THEORY
On Time
PETER DIAMOND
0 521 46289 4 hardback
Strategic Foundations of General Equilibrium:

Dynamic Matching and Bargaining Games
DOUGLAS GALE
0 521 64330 9 hardback
0 521 64410 0 paperback
Economics and Language

ARIEL RUBINSTEIN
0521 59306 9 hardback
0521 78990 7 paperback

Bargaining Games
Douglas Gale
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THE CHURCHILL LECTURES IN ECONOMIC THEORY
Strategic Foundations of
General Equilibrium
Dynamic Matching and
Bargaining Games
DOUGLAS GALE

Bargaining Games
Douglas Gale
Frontmatter
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PUBLISHED BY THE PRESS SYNDICATE OF THE UNIVERSITY OF CAMBRIDGE

The Pitt Building, Trumpington Street, Cambridge, United Kingdom
CAMBRIDGE UNIVERSITY PRESS

THE EDINBURGH BUILDING, CAMBRIDGE CB2 2RU, UK
www.cup.cam.ac.uk
40 WEST 20TH STREET, NEW YORK, NY 10011±4211, USA
www.cup.org
10 Stamford Road, Oakleigh, Melbourne 3166, Australia
Ruiz de AlarcoÂn 13, 28014 Madrid, Spain
# Douglas Gale 2000
This book is in copyright. Subject to statutory exception

and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without
the written permission of Cambridge University Press.
First published 2000
Printed in the United Kingdom at the University Press, Cambridge
Typeface Trump Medieval System 3B2 [KW]
A catalogue record for this book is available from the British Library
Library of Congress Cataloguing in Publication data
Gale, Douglas.
Strategic foundations of general equilibrium: dynamic matching and
bargaining games/Douglas Gale.
p. cm. ± (Churchill lectures in economic theory)
Includes bibliographical references.
ISBN 0 521 64330 9 hbk 64410 pbk
1. Competition. 2. Equilibrium (Economics) 3. Game theory. I. Title.
II. Churchill Lectures in Economic Theory
HD41.G35 2000 338.6 0 048 0 015193±dc21 99-462249
ISBN 0 521 64330 9 hardback

ISBN 0 521 64410 0 paperback

Bargaining Games
Douglas Gale
Frontmatter
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To my teacher
F R A N K H. H A H N

Bargaining Games
Douglas Gale
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CONTENTS
Acknowledgments page xi
1 Markets and games 1

1.1 Strategic foundations of perfect competition 1
1.2 Why strategic foundations? 2
1.3 Cooperative market games 6
1.4 Non-cooperative market games 10
1.5 Dynamic matching and bargaining models 13
1.6 Open questions 25
2 Perfect competition 41
2.1 Introduction 41
2.2 Pure exchange economics 43
2.3 Dynamic matching and bargaining games 49
2.4 Equilibrium 55
2.5 The Edgeworth Property 59
2.6 Ef®ciency 61
2.7 Competitive sequences of economies 65
2.8 Existence 76
2.9 Ef®ciency with discounting 85
2.10 Random matching 92
2.11 Mixed equilibria 104
2.12 A summing up 108
3 Continuity and anonymity 110

3.1 Rubinstein and Wolinsky (1990) 110
3.2 Bounded rationality and uniqueness 119
3.3 The Limit Principle 127
3.4 Repeated games 132
3.5 Limited memory 134
3.6 Large anonymous games 138
ix

Bargaining Games
Douglas Gale
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Contents
3.7 Non-anonymous games 144
4 Bounded rationality 157

4.1 Imitation and experimentation 158
4.2 A behavioral model of competition 166
4.3 Convergence to competitive prices 179
4.4 Extensions 192
5 Afterthoughts 204
References 208
Index 214

Bargaining Games
Douglas Gale
Frontmatter
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ACKNOWLEDGMENTS
This book is based on a series of three lectures delivered in

the University of Cambridge in November 1997. Frank
Hahn initially invited me to give these lectures. The
Master and Fellows of Churchill College provided hospi-
tality while I was in Cambridge. Jayasri Dutta was a
charming host. Sudipto Bhattacharya, my discussant,
offered a witty and insightful commentary on the lectures.
Hamid Sabourian, in probing conversations in Cambridge
and New York, made a number of helpful comments, espe-
cially on the subject of chapter 3. Robert Rosenthal read
chapter 4 and made useful comments. Juan Dubra carefully
read an early version of the manuscript and made numer-
ous corrections and suggestions, as did Viral Acharya on a
late version of chapter 2. The Cambridge University Press
underwrote this lecture series and Patrick McCartan and
Ashwin Rattan of the Cambridge University Press handled
the publishing. The National Science Foundation and the
C.V. Starr Center at New York University provided ®nan-
cial support for the research on which these lectures were
based. To all these, I am very grateful.
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Bargaining Games
Douglas Gale
Index
More information
INDEX
agents auction market 17±20

endowments 44 Aumann, R. 8, 34, 107, 137±8, 144
entry and exit 15, 18±21, 87 automata, ®nite 127, 136±7
®nite number 21, 25±7, 41±109
impact of one 41±2, 66±7
in®nite number 18±21 Banach space 149
market power 85 Banerjee, A. 159
maximization problem 9 Banks, J. 160
one period matches 18±19, 22 bargaining
in pure exchange economies 44 alternating-offers 13±15, 50
see also behavior costs of 14, 29
Aghion, P. 160 pairwise 50±1
Al-Najjar, N. 153 theory 13
allocation see also dynamic matching and
attainable 45±9, 79±82, 92 bargaining games (DMBG)
core 9 behavior
Pareto-ef®cient 78±9 adaptive 157
process 59 determinate 6±7
anonymity herd 159
in DMBG model 110, 112±13, rational 36
116, 118, 130±1, 138±44, rule of thumb 157
151±2 behavioral model
lack of 144±56 the market 166±7
Lemma 8 141±3 market game 168±71
main lemma 139±41 market-clearing prices 167±8
and number of agents 32±4 behavioral rules 38, 171±4, 195,
referee's lemma 149±53 200±1
Theorem 1 111±16, 118, 123, Benaim, M. 160
127 Bertrand competition 198
Theorem 2 113±16, 123 Bessell's Inequality 153
Theorem 3 115±17, 119 Bikhchandani, S. 159
Theorem 4 117±19 Billingsley, P. 134, 140
unnatural 27 Binmore, K. 13, 22, 87, 157
Anti-Folk Theorem 130±1 Bolton, P. 160
Arrow, K. 2, 36, 204±5, 207 Borel ®eld 175
214

Bargaining Games
Douglas Gale
Index
More information
Index
bounded rationality equilibrium payoffs 94±7
Lemma 1 178 theorem 184±5
Lemma 4 182 Cournot, A. A. 10±12, 68, 127±9
Lemma 5 182 Cournot model 161
Lemma 8 185 Cournot±Shubik Market Game
Lemma 9 186 (CSMG) 11±12
Lemma 10 187 cycles, endogenous 164±5
Lemma 11 191
Lemma 12 191±2 Dagan, N. 24
Lemma A 179±81 Debreu, G. 2, 104, 204±5, 207
budget balance 41±2, 70 Dirac distribution 175
discounting 29±31
absence of 114±15, 119
Caplin, A. 158 and ef®ciency 85±92
Cauchy 65, 98 with random matching 100±3
Chamley, C. 158±9 in SPE 115±17
Chatterjee, K. 127 two interpretations 86±7
Coase Conjecture 28 disequilibrium 35±8
Cobb±Douglas duopoly 10±12
preferences 73±4 dynamic analysis 36±7
utility function 46 dynamic matching and bargaining
collusion 128±9, 131 games (DMBG) 2, 12±24, 27,
commodities 43±4 32, 42±109
competitive equilibria 19, 77±8 and discounting 29
limit 75±6 a stochastic game 57
and random matching 107±8
sequences 75, 103 economics
competitive limit theorem 42±3, de®nition 38
74±6 normative 6
consumption Edgeworth, F. Y. 6±7, 14, 35
continuous 87 Edgeworth Box economy 4, 7, 104
sets 44, 46 Edgeworth Process 59
continuity 108, 110, 118, 127, 143 Edgeworth Property 59±60
of consumption 87 ef®ciency 41±2, 61±5
of play 66±9 asymptotic 89, 103
in public goods provision 145±9 with discounting 85±92
Continuity Principle 144, 149, pairwise 45±9, 93
157 with random matching 97±100
continuum see also Pareto-ef®ciency
agents 27 Egroff's Theorem 143
assumptions 25±31 Ellison, G. 159
model 130 equilibria
of outcomes 117±19 continuum 127
contract curve 7±8 de®ned 55
convergence and disequilibrium 35±8
215

Bargaining Games
Douglas Gale
Index
More information
Index
(equilibria cont.) large anonymous 138±44
dynamics 36 market 9±12
general 39, 202±5 non-anonymous 144±56
in the limit 66 non-cooperative 10±12, 49±50,
mixed 104±8 55
multiple 116±17 path 52±4
non-cooperative 23±4 pivotal players 153±6
non-stationary 21 repeated 26±7, 34, 43, 57, 128±
partial 38±9, 204±5; to general 39
202±3 rules of 49
payoffs 101 states of 34, 90±1
sequential 111 general equilibrium 39, 202±5
stability 35±6 Goldman, S. 48
Walras 24, 207 Green, E. 29, 68, 128±9, 131±2,
see also competitive equilibria; 136, 153
Markov; Nash equilibrium; Gul, F. 28, 159
sub-game perfect equilibrium
evolutionary game theory 37±8 Hahn, F. 36
experimentation 159±62 Halmos, P. 142
learning from 172±3 Harris, C. 160
permanent 160±1 Hayek, F. A. 32
random 160 herd behavior 159
role of 165 Herrero, M. 22
virtual 172 Hicks, J. 9±10
Hilbert space 152
fair net trades 23±4 Hildenbrand, W. 8
feasibility Hirsch, M. 160
requirements 24 Hirshleifer, D. 159
of trades 3±4
®ctitious play 37 imitation 159±61
Folk Theorem 26, 43, 57, 129 independence assumptions 82±3
Fourier coef®cients 152 indifference surface 46
free-rider problem 158±9 information
Fudenberg, D. 37, 57, 129, 159±60 asymmetric 33
economy in 32
Gale, D. 18, 20±1, 23, 70, 77, institutional structure, centra-
158±66 lized 12
game theory 1, 3±4 interiority assumption 81, 83
see also dynamic matching and invisible hand 204, 206
bargaining games (DMBG)
games Jordan, J. 160
cooperative 8±10 Jovanovic, B. 130
extensive-form 4
history 53 Kalai, E. 160
increasing sequence 140 Kandori, M. 37, 173
216

Bargaining Games
Douglas Gale
Index
More information
Index
Karlin, S. 95, 102 path 88±9, 94
Keynes, J. M. 40, 203 sequence of 65±76
Kreps, D. 37, 160 Markov Property 98, 118, 130,
Krishna, V. 160 135, 144
Kuhn±Tucker Theorem 46 Markov strategies 58, 110, 121,
144
Marshall, A. 2, 35, 38
Leahy, J. 158 Marshallian markets 15±21, 25±6,
learning 37±8 203
from experimentation 172±3 Martingale Convergence Theorem
rational 160 95±6, 102
social 158±9 Mas-Colell, A. 8
Lehrer, E. 153, 160 Maskin, E. 57
Limit Principle 129±31, 143, 145 Masso, J. 130
limit theorems 5, 25, 42±3, 74±6 matching 50±1
linearity 70±3 endogenous 117, 119
Lucas, R. 36 one period 18±19, 22
Lundholm, R. 159 random 92±103, 107±8, 111
Lusin's Theorem 142±3 memory 62, 144, 155±6
bounded 120±4
McKenzie, L. 2, 204±5, 207 ®nite 137±8
McLennan, A. 23±4 imperfect 124±7
Madden, P. 59 limited 33±5, 58, 134±9
Mailath, G. 37, 148, 173 Theorem 5 121±2
Makowski, L. 4 Theorem 6 125±6, 184
Marimon, R. 160 Theorem 7 135±6, 185, 194
market power 85 see also recall
market-maker 168±71, 197 memoryless 58
markets Meyn, S. 177±8
auction 17±20 monopoly 124, 129
incomplete 205±6 Morgenstern, O. 3, 16
Marshallian 15±21, 25±6, 203 Moulin, H. 13
multiple 202±3 Myerson, R. 146
Markov assumptions 33±5, 71,
113, 120 Nash, J. 10, 14
Markov chain 162, 174±9 Nash bargaining solution 15
®nite 192 Nash equilibrium 11, 14, 36±7,
time-homogeneous 177 55±7, 68, 127±8, 133, 143
Markov equilibria 144, 157 Nash Program 10, 49±50
Markov perfect equilibria (MPE) Nash reversion strategies 129
28, 30, 58±76, 108, 135±8 Nash strategies 130
asymptotic properties 28±31 Nash±Cournot equilibrium 131
asymptotically pure 99±100, Nature 104±5, 107
104±7 Neeman, Z. 153
existence of 76±85, 100 Negishi, T. 59
217

Bargaining Games
Douglas Gale
Index
More information
Index
Non-Intersection Property 84±5 prices 3
null recurrence 162±3 admissible 192±4
bid and ask 168±70, 192, 196
bid±ask spread 183±4
oligopoly 127±9 convergence to competitive
Osborne, M. 15, 70 183±92
Ostroy, J. 4 in CSMG model 12
equilibrium 16±17
pairwise-ef®ciency 45±9, 93 limit 168±70
Pareto-ef®ciency 30±1, 45±9, 61, market-clearing 167±8
103 and quantity 201±2
with discounting 89±92, 97 production 41
participation, incomplete 206±7 public goods provision 145±9, 155
payoffs 54±5, 61 punishment 33, 112, 130
convergence 94±7 pure exchange economy 41, 43±9
equilibrium 88±9, 101
functions 87 rationality, bounded 119, 134,
perfect competition 41±109 136±8, 157±9
Lemma 4 71±4 recall see memory
Lemma 13 92 Referee's Theorem 153±5
Proposition 1 47, 78, 99 Revelation Principle 146
Proposition 2 60 Rob, R. 37, 173
Proposition 3 63, 97±8 Roberts, K. 68, 127±9
Proposition 6 78 Rosenthal, R. 130, 158±66
Proposition 7 79±81 Royden, H. 149, 152±3
Proposition 8 81±2 Rubinstein, A. 13±21, 23±6, 29±
Proposition 11 89 30, 50, 70, 86±7, 110±19, 136
Proposition 12 89
Proposition 15 96±7 Sabourian, H. 127, 131±2, 143, 153
Proposition 16 97±9 Schmeidler, D. 8, 24
Proposition 17 103 search
Proposition 18 103 costs 29
Proposition 19 106 random 161±2, 172±3
relevance of 4±5 structures 198
strategic foundations 1±6: theory 13
Theorem 5 76; Theorem 9 trading partners 17
83±4; Theorem 14 92; Selten, R. 56, 151
Theorem 20 107 Serrano, R. 24
Postlewaite, A. 148±9 Shaked, A. 15
preferences Shapley, L. 8, 11
Cobb±Douglas 73±4 Shubik, M. 8, 11
in pure exchange economies 44 Sjostrom, T. 160
smooth 45±6 Skorohod embedding theorem 143
see also utility function Smith, A. 1, 204, 206
Prescott, E. C. 36 Smith, L. 159
218

Bargaining Games
Douglas Gale
Index
More information
Index
Smorodinsky, R. 153 multiple units 194±9
social norms 62 pairwise 61
Sonnenschein, H. 23±4, 28 rules 77, 80
Sorensen, P. 159 volume-maximizing 179±82
Sorin, S. 137±8 ``trembling hand'' 151±2, 154±5
Stahl, I. 13±14, 50, 86, 116 Tweedie, R. 177±8
Starr, R. 48
Stokey, N. 36 uncertainty 145, 151
strategies uniqueness 79, 83
complementary and substitute utility 61
164±5 and payoffs 54±5
feasible 53±4 utility function 62±3, 97
®nite 192±4 Cobb±Douglas 46
Markov 58, 110, 121, 144 curvature 69±71, 73
pro®le 55±6 in pure exchange economies 44
subgame-perfect equilibrium Uzawa, H. 59
(SPE) 14, 23, 26, 28, 56±8, 78,
106±7 Vind, K. 8, 24
continuum of outcomes 117±19 Volij, O. 24
discounting 115±17
von Neumann, J. 3, 16
with imperfect memory 125±6
indeterminate 57
Walras, L. 2, 35, 39
quasi-stationary 16
Walras allocation 8, 11, 28±9, 77,
repeated games 133, 135±6
79±81, 104, 107
seller's payoff 113
Walrasian equilibria 24, 207
submartingale 101±2
Walrasian models 21±3
substitution, limited 73±4
Walrasian outcomes 106±7
Sundaram, R. 160
Weibull, J. 37
Welch, I. 159
Taylor, P. 95, 102
theory predictions 50 Welfare Economics Theorems 41
time 50±1 Wilson, R. 28
time-preference 86±7 Wolinsky, A. 13, 15±20, 22±6, 30,
Tirole, J. 129 87, 110±19
trading
multiple goods 199±202 Young, P. 37, 173
219

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Cambridge University Press

0521643309 - Strategic Foundations of General Equilibrium: Dynamic Matching and

Strategic Foundations of General Equilibrium

The theory of competition has held a central place in economic

DOUGLAS G A L E is Professor of Economics in New York

© Cambridge University Press www.cambridge.org

CHURCHILL LECTURES IN ECONOMIC THEORY

Strategic Foundations of General Equilibrium:

Economics and Language

© Cambridge University Press www.cambridge.org

THE CHURCHILL LECTURES IN ECONOMIC THEORY

© Cambridge University Press www.cambridge.org

PUBLISHED BY THE PRESS SYNDICATE OF THE UNIVERSITY OF CAMBRIDGE

CAMBRIDGE UNIVERSITY PRESS

# Douglas Gale 2000

This book is in copyright. Subject to statutory exception

First published 2000

Printed in the United Kingdom at the University Press, Cambridge

Typeface Trump Medieval System 3B2 [KW]

Library of Congress Cataloguing in Publication data

ISBN 0 521 64330 9 hardback

© Cambridge University Press www.cambridge.org

© Cambridge University Press www.cambridge.org

1 Markets and games 1

3 Continuity and anonymity 110

© Cambridge University Press www.cambridge.org

4 Bounded rationality 157

© Cambridge University Press www.cambridge.org

This book is based on a series of three lectures delivered in

© Cambridge University Press www.cambridge.org

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