Arrow–Debreu model

In mathematical economics, the Arrow–Debreu model is a theoretical general equilibrium model. It posits
that under certain economic assumptions (convex preferences, perfect competition, and demand
independence) there must be a set of prices such that aggregate supplies will equal aggregate demands for
every commodity in the economy.[1]

The model is central to the theory of general (economic) equilibrium and it is often used as a general
reference for other microeconomic models. It was proposed by Kenneth Arrow, Gérard Debreu in 1954,[1]
and Lionel W. McKenzie independently in 1954,[2] with later improvements in 1959.[3][4]

The A-D model is one of the most general models of competitive economy and is a crucial part of general
equilibrium theory, as it can be used to prove the existence of general equilibrium (or Walrasian equilibrium)
of an economy. In general, there may be many equilibria.

Arrow (1972) and Debreu (1983) were separately awarded the Nobel Prize in Economics for their
development of the model. McKenzie however did not.[5]

Preliminary concepts

Convex sets and fixed points

In 1954, McKenzie and the pair Arrow and Debreu independently

proved the existence of general equilibria by invoking the Kakutani
fixed-point theorem on the fixed points of a continuous function from
a compact, convex set into itself. In the Arrow–Debreu approach,
convexity is essential, because such fixed-point theorems are
inapplicable to non-convex sets. For example, the rotation of the unit
circle by  90  degrees lacks fixed points, although this rotation is a
continuous transformation of a compact set into itself; although
compact, the unit circle is non-convex. In contrast, the same rotation
applied to the convex hull of the unit circle leaves the point  (0,0)
fixed. Notice that the Kakutani theorem does not assert that there
exists exactly one fixed point. Reflecting the unit  disk across the y- A quarter turn of the convex unit disk
axis leaves a vertical segment fixed, so that this reflection has an leaves the point (0,0) fixed but
infinite number of fixed points. moves every point on the non–
convex unit circle.

Non-convexity in large economies

The assumption of convexity precluded many applications, which were discussed in the Journal of Political
Economy from  1959 to  1961 by Francis  M.  Bator, M.  J.  Farrell, Tjalling  Koopmans, and
Thomas  J.  Rothenberg.[6] Ross  M. Starr  (1969) proved the existence of economic equilibria when some
consumer preferences need not be convex.[6] In his paper, Starr proved that a "convexified" economy has
general equilibria that are closely approximated by "quasi-equilbria" of the original economy; Starr's proof
used the Shapley–Folkman theorem.[7]

Formal statement

The contents of both theorems [fundamental theorems of welfare economics] are old beliefs in
economics. Arrow and Debreu have recently treated this question with techniques permitting
proofs.

— Gérard Debreu, Valuation equilibrium and Pareto optimum (1954)

This statement is precisely correct; once there were beliefs, now there was knowledge. But more
was at stake. Great scholars change the way that we think about the world, and about what and
who we are. The Arrow-Debreu model, as communicated in Theory of Value changed basic
thinking, and it quickly became the standard model of price theory. It is the “benchmark” model
in Finance, International Trade, Public Finance, Transportation, and even macroeconomics... In
rather short order it was no longer “as it is” in Marshall, Hicks, and Samuelson; rather it became
“as it is” in Theory of Value.

— Hugo Sonnenschein, remarks at the Debreu conference, Berkeley, 2005

This section follows the presentation in,[8] which is based on.[9]

Intuitive description of the Arrow–Debreu model

The Arrow–Debreu model models an economy as a combination of three kinds of agents: the households,
the producers, and the market. The households and producers transact with the market, but not with each
other directly.

The households possess endowments (bundles of commodities they begin with), which one may think of as
"inheritance". For the sake of mathematical clarity, all households are required to sell all their endowment to
the market at the beginning. If they wish to retain some of the endowment, they would have to repurchase
from the market later. The endowments may be working hours, use of land, tons of corn, etc.

The households possess proportional ownerships of producers, which can be thought of as joint-stock
companies. The profit made by producer is divided among the households in proportion to how much
stock each household holds for the producer . Ownership is imposed at the beginning, and the households
may not sell, buy, create, or discard them.

The households receive a budget, as the sum of income from selling endowments and dividend from
producer profits.

The households possess preferences over bundles of commodities, which under the assumptions given,
makes them utility maximizers. The households choose the consumption plan with the highest utility that
they can afford using their budget.

The producers are capable of transforming bundles of commodities into other bundles of commodities. The
producers have no separate utility functions. Instead, they are all purely profit maximizers.
The market is only capable of "choosing" a market price vector, which is a list of prices for each commodity,
which every producer and household takes (there is no bargaining behavior—every producer and household
is a price taker). The market has no utility or profit. Instead, the market aims to choose a market price vector
such that, even though each household and producer is maximizing their own utility and profit, their
consumption plans and production plans "harmonize". That is, "the market clears". In other words, the
market is playing the role of a "Walrasian auctioneer".

How an Arrow–Debreu model moves from beginning to end.

households producers

receive endowment and ownership of producers

sell all endowment to the market

plan production to maximize profit

enter purchase agreements between the market and

each other

perform production plan

sell everything to the market

send all profits to households in proportion to ownership

plan consumption to maximize utility under budget

constraint
buy the planned consumption from the market

Notation setup

In general, we write indices of agents as superscripts, and vector coordinate indices as subscripts.

useful notations for real vectors

if
is the set of such that
is the set of such that

is the N-simplex. We often call it the price

simplex since we will sometimes scale the price vector to lie on it.

market
The commodities are indexed as . Here is the number of commodities that exists
in the economy. It is a finite number.
The price vector is a vector of length , with each coordinate being
the price of a commodity. The prices may be zero or positive.

households
The households are indexed as .
 Each household begins with an endowment of commodities .
Each household begins with a tuple of ownerships of the producers . The
ownerships satisfy .

The budget that the household receives is the sum of its income from selling endowments at
the market price, plus profits from its ownership of producers:

( stands for money)

Each household has a Consumption Possibility Set .
Each household has a preference relation over .
With assumptions on (given in the next section), each preference relation is representable
by a utility function by the Debreu theorems. Thus instead of maximizing
preference, we can equivalently state that the household is maximizing its utility.
A consumption plan is a vector in , written as .
is the set of consumption plans at least as preferable as .
The budget set is the set of consumption plans that it can afford:

.
For each price vector , the household has a demand vector for commodities, as
. This function is defined as the solution to a constraint maximization problem. It depends on
both the economy and the initial distribution.

It may not be well-defined for all . However, we will use enough assumptions such
that that it is well-defined at equilibrium price vectors.

producers
The producers are indexed as .
Each producer has a Production Possibility Set . Note that the supply vector may
have both positive and negative coordinates. For example, indicates a production
plan that uses up 1 unit of commodity 1 to produce 1 unit of commodity 2.
A production plan is a vector in , written as .
For each price vector , the producer has a supply vector for commodities, as .
This function will be defined as the solution to a constraint maximization problem. It depends
on both the economy and the initial distribution.

It may not be well-defined for all . However, we will use enough assumptions such
that that it is well-defined at equilibrium price vectors.
The profit is
aggregates

aggregate consumption possibility set .

aggregate production possibility set .

aggregate endowment

aggregate demand

aggregate supply

excess demand

the whole economy

An economy is a tuple . That is, it is a tuple specifying the

commodities, the consumer preferences, consumption possibility sets, and the producers'
production possibility sets.
An economy with initial distribution is an economy, along with an initial distribution tuple
for the economy.
A state of the economy is a tuple of price, consumption plans, and production plans for each
household and producer: .
A state is feasible iff each , each , and .

The feasible production possibilities set, given endowment , is

.
Given an economy with distribution, the state corresponding to a price vector is
.
Given an economy with distribution, a price vector is an equilibrium price vector for the
economy with initial distribution, iff

That is, if a commodity is not free, then supply exactly equals demand, and if a commodity is
free, then supply is equal or greater than demand (we allow free commodity to be
oversupplied).
 A state is an equilibrium state iff it is the state corresponding to an equilibrium price vector.

Assumptions

on the households
assumption explanation can we relax it?

Technical assumption No. It is necessary for the

is closed
necessary for proofs to work. existence of demand functions.

local nonsatiation: Households always want to No. It is necessary for Walras's

consume a little more. law to hold.

Yes, to mere convexity, with

strictly diminishing marginal
is strictly convex Kakutani's fixed-point theorem.
utility
See next section.

Yes, to nonconvexity, with

is convex diminishing marginal utility
Shapley–Folkman lemma.
Technical assumption No. If the preference is not
necessary for the existence of continuous, then the excess
continuity: is closed.
utility functions by the Debreu demand function may not be
theorems. continuous.

For two consumption bundles,

Yes, to mere convexity, with
any bundle strictly between
is strictly convex. Kakutani's fixed-point theorem.
them is strictly better than the
See next section.
lesser.

For two consumption bundles,

Yes, to nonconvexity, with
is convex. any bundle between them is no
Shapley–Folkman lemma.
worse than the lesser.
The household always has at least one No. It is necessary for the
no bankruptcy
feasible consumption plan. existence of demand functions.

on the producers
assumption explanation can we relax it?

is strictly Yes, to mere convexity, with Kakutani's fixed-

diseconomies of scale
convex point theorem. See next section.

Yes, to nonconvexity, with Shapley–Folkman

is convex no economies of scale
lemma.

contains 0. Producers can close down for free.

Technical assumption necessary for No. It is necessary for the existence of supply
is a closed set
proofs to work. functions.

is There is no arbitrarily large "free

No. Economy needs scarcity.
bounded lunch".

is The economy cannot reverse arbitrarily

bounded large transformations.

Imposing an artificial restriction

The functions are not necessarily well-defined for all price vectors . For example, if producer
1 is capable of transforming units of commodity 1 into units of commodity 2, and we have
, then the producer can create plans with infinite profit, thus , and is
undefined.

Consequently, we define "restricted market" to be the same market, except there is a universal upper bound
, such that every producer is required to use a production plan , and each household is required
to use a consumption plan . Denote the corresponding quantities on the restricted market with a
tilde. So for example, is the excess demand function on the restricted market.[10]

is chosen to be "large enough" for the economy, so that the restriction is not in effect under equilibrium
conditions (see next section). In detail, is chosen to be large enough such that:

For any consumption plan such that , the plan is so "extravagant" that even
if all the producers coordinate, they would still fall short of meeting the demand.
For any list of production plans for the economy , if , then

for each . In other words, for any attainable production plan under the given
endowment , each producer's individual production plan must lie strictly within the restriction.

Each requirement is satisfiable.

Define the set of attainable aggregate production plans to be

, then under the

assumptions for the producers given above (especially the "no arbitrarily large free lunch"
assumption), is bounded for any (proof omitted). Thus the first requirement is
satisfiable.
Define the set of attainable individual production plans to be

then under the assumptions for the producers given above (especially the "no arbitrarily large
transformations" assumption), is bounded for any (proof omitted). Thus the
second requirement is satisfiable.

The two requirements together imply that the restriction is not a real restriction when the production plans
and consumption plans are "interior" to the restriction.

At any price vector , if , then exists and is equal to . In other words, if

the production plan of a restricted producer is interior to the artificial restriction, then the
unrestricted producer would choose the same production plan. This is proved by exploiting
the second requirement on .
If all , then the restricted and unrestricted households have the same budget.
Now, if we also have , then exists and is equal to . In other words, if
the consumption plan of a restricted household is interior to the artificial restriction, then the
unrestricted household would choose the same consumption plan. This is proved by
exploiting the first requirement on .
These two propositions imply that equilibria for the restricted market are equilibria for the unrestricted
market:

Theorem  —  If is an equilibrium price vector for the restricted market, then it is also an
equilibrium price vector for the unrestricted market. Furthermore, we have
.

Existence of general equilibrium

As the last piece of the construction, we define Walras's law:

The unrestricted market satisfies Walras's law at iff all are defined, and
, that is,

The restricted market satisfies Walras's law at iff .

Walras's law can be interpreted on both sides:

On the side of the households, it is saying that the aggregate household expenditure is equal
to aggregate profit and aggregate income from selling endowments. In other words, every
household spends its entire budget.
On the side of the producers, it is saying that the aggregate profit plus the aggregate cost
equals the aggregate revenue.

Theorem —  satisfies weak Walras's law: For all ,

and if , then for some .

Proof sketch

If total excess demand value is exactly zero, then every household has spent all their budget.
Else, some household is restricted to spend only part of their budget. Therefore, that
household's consumption bundle is on the boundary of the restriction, that is, .
We have chosen (in the previous section) to be so large that even if all the producers
coordinate, they would still fall short of meeting the demand. Consequently there exists some
commodity such that
 Theorem — An equilibrium price vector exists for the restricted market, at which point the
restricted market satisfies Walras's law.

Proof sketch

By definition of equilibrium, if is an equilibrium price vector for the restricted market, then
at that point, the restricted market satisfies Walras's law.

is continuous since all are continuous.

Define a function

on the price simplex, where is a fixed positive constant.

By the weak Walras law, this function is well-defined. By Brouwer's fixed-point theorem, it
has a fixed point. By the weak Walras law, this fixed point is a market equilibrium.

Note that the above proof does not give an iterative algorithm for finding any equilibrium, as there is no
guarantee that the function is a contraction. This is unsurprising, as there is no guarantee (without further
assumptions) that any market equilibrium is a stable equilibrium.

Corollary — An equilibrium price vector exists for the unrestricted market, at which point
the unrestricted market satisfies Walras's law.

Uzawa equivalence theorem

(Uzawa, 1962)[11] showed that the existence of general equilibrium in an economy characterized by a
continuous excess demand function fulfilling Walras’s Law is equivalent to Brouwer fixed-Point theorem.
Thus, the use of Brouwer's fixed-point theorem is essential for showing that the equilibrium exists in
general.[12]

Fundamental theorems of welfare economics

In welfare economics, one possible concern is finding a Pareto-optimal plan for the economy.

Intuitively, one can consider the problem of welfare economics to be the problem faced by a master planner
for the whole economy: given starting endowment for the entire society, the planner must pick a feasible
master plan of production and consumption plans . The master planner has a wide
freedom in choosing the master plan, but any reasonable planner should agree that, if someone's utility can
be increased, while everyone else's is not decreased, then it is a better plan. That is, the Pareto ordering
should be followed.
Define the Pareto ordering on the set of all plans by
iff for all .

Then, we say that a plan is Pareto-efficient with respect to a starting endowment , iff it is feasible, and there
does not exist another feasible plan that is strictly better in Pareto ordering.

In general, there are a whole continuum of Pareto-efficient plans for each starting endowment .

With the set up, we have two fundamental theorems of welfare economics:[13]

First fundamental theorem of welfare economics  —  Any market equilibrium state is

Pareto-efficient.

Proof sketch

The price hyperplane separates the attainable productions and the Pareto-better
consumptions. That is, the hyperplane separates and
, where is the set of all , such that , and

. That is, it is the set of aggregates of all possible consumption plans that
are strictly Pareto-better.

The attainable productions are on the lower side of the price hyperplane, while the Pareto-
better consumptions are strictly on the upper side of the price hyperplane. Thus any Pareto-
better plan is not attainable.

Any Pareto-better consumption plan must cost at least as much for every
household, and cost more for at least one household.
Any attainable production plan must profit at most as much for every producer.

Second fundamental theorem of welfare economics  —  For any total endowment , and
any Pareto-efficient state achievable using that endowment, there exists a distribution of
endowments and private ownerships of the producers, such that the
given state is a market equilibrium state for some price vector .

Proof idea: any Pareto-optimal consumption plan is separated by a hyperplane from the set of attainable
consumption plans. The slope of the hyperplane would be the equilibrium prices. Verify that under such
prices, each producer and household would find the given state optimal. Verify that Walras's law holds, and
so the expenditures match income plus profit, and so it is possible to provide each household with exactly the
necessary budget.

Proof
Since the state is attainable, we have . The equality does not necessarily

hold, so we define the set of attainable aggregate consumptions

. Any aggregate consumption bundle in is
attainable, and any outside is not.

Find the market price .

Define to be the set of all , such that ,

and . That is, it is the set of aggregates of all possible

consumption plans that are strictly Pareto-better. Since each is convex,
and each preference is convex, the set is also convex.

Now, since the state is Pareto-optimal, the set must be unattainable with
the given endowment. That is, is disjoint from . Since both sets are
convex, there exists a separating hyperplane between them.

Let the hyperplane be defined by , where , and

. The sign is chosen such that and

Claim: .

Suppose not, then there exists some such that . Then

if is large enough, but we also have ,
contradiction.

We have by construction , and . Now we claim: .

For each household , let be the set of consumption plans for that
are at least as good as , and be the set of consumption plans for
that are strictly better than .

By local nonsatiation of , the closed half-space contains

.

By continuity of , the open half-space contains .

Adding them up, we find that the open half-space contains .

Claim (Walras's law):

Since the production is attainable, we have , and since

, we have .
 By construction of the separating hyperplane, we also have
, thus we have an equality.

Claim: at price , each producer maximizes profit at ,

If there exists some production plan such that one producer can reach
higher profit , then

but then we would have a point in on the other side of the

separating hyperplane, violating our construction.

Claim: at price and budget , household maximizes utility at .

Otherwise, there exists some such that and .

Then, consider aggregate consumption bundle . It is in

, but also satisfies . But this contradicts previous

claim that .

By Walras's law, the aggregate endowment income and profit exactly equals aggregate
expenditure. It remains to distribute them such that each household obtains exactly
as its budget. This is trivial.

Here is a greedy algorithm to do it: first distribute all endowment of commodity

1 to household 1. If household 1 can reach its budget before distributing all of
it, then move on to household 2. Otherwise, start distributing all endowment of
commodity 2, etc. Similarly for ownerships of producers.

Convexity vs strict convexity

The assumptions of strict convexity can be relaxed to convexity. This modification changes supply and
demand functions from point-valued functions into set-valued functions (or "correspondences"), and the
application of Brouwer's fixed-point theorem into Kakutani's fixed-point theorem.

This modification is similar to the generalization of the minimax theorem to the existence of Nash equilibria.

The two fundamental theorems of welfare economics holds without modification.

 converting from strict convexity to convexity
strictly convex case convex case

is strictly convex is convex

is strictly convex is convex

is strictly convex is convex

is point-valued is set-valued

is continuous has closed graph ("upper hemicontinuous")

for any

... ...

equilibrium exists by Brouwer's fixed-point theorem equilibrium exists by Kakutani's fixed-point theorem

Equilibrium vs "quasi-equilibrium"

The definition of market equilibrium assumes that every household performs utility maximization, subject to
budget constraints. That is,

The dual problem would be cost minimization subject to utility constraints. That is,

for some real number . The duality gap between the two problems is nonnegative, and may be positive.
Consequently, some authors study the dual problem and the properties of its "quasi-equilibrium"[14] (or
"compensated equilibrium"[15]). Every equilibrium is a quasi-equilibrium, but the converse is not necessarily
true.[15]

Extensions

Accounting for strategic bargaining

In the model, all producers and households are "price takers", meaning that they simply transact with the
market using the price vector . In particular, behaviors such as cartel, monopoly, consumer coalition, etc are
not modelled. Edgeworth's limit theorem shows that under certain stronger assumptions, the households can
do no better than price-take at the limit of an infinitely large economy.

Setup

In detail, we continue with the economic model on the households and producers, but we consider a different
method to design production and distribution of commodities than the market economy. It may be interpreted
as a model of a "socialist" economy.
 There is no money, market, or private ownership of producers.
Since we have abolished private ownership, money, and the profit motive, there is no point in
distinguishing one producer from the next. Consequently, instead of each producer planning
individually , it is as if the whole society has one great producer producing
.
Households still have the same preferences and endowments, but they no longer have
budgets.
Producers do not produce to maximize profit, since there is no profit. All households come
together to make a state —a production and consumption plan for the whole
economy—with the following constraints:

Any nonempty subset of households may eliminate all other households, while retaining
control of the producers.

This economy is thus a cooperative game with each household being a player, and we have the following
concepts from cooperative game theory:

A blocking coalition is a nonempty subset of households, such that there exists a strictly
Pareto-better plan even if they eliminate all other households.
A state is a core state iff there are no blocking coalitions.
The core of an economy is the set of core states.

Since we assumed that any nonempty subset of households may eliminate all other households, while
retaining control of the producers, the only states that can be executed are the core states. A state that is not a
core state would immediately be objected by a coalition of households.

We need one more assumption on , that it is a cone, that is, for any . This
assumption rules out two ways for the economy to become trivial.

The curse of free lunch: In this model, the whole is available to any nonempty coalition,
even a coalition of one. Consequently, if nobody has any endowment, and yet contains
some "free lunch" , then (assuming preferences are monotonic) every household would
like to take all of for itself, and consequently there exists *no* core state. Intuitively, the
picture of the world is a committee of selfish people, vetoing any plan that doesn't give the
entire free lunch to itself.
The limit to growth: Consider a society with 2 commodities. One is "labor" and another is
"food". Households have only labor as endowment, but they only consume food. The
looks like a ramp with a flat top. So, putting in 0-1 thousand hours of labor produces 0-1
thousand kg of food, linearly, but any more labor produces no food. Now suppose each
household is endowed with 1 thousand hours of labor. It's clear that every household would
immediately block every other household, since it's always better for one to use the entire
for itself.

Main results (Debreu and Scarf, 1963)

Proposition — Market equilibria are core states.

 Proof

Define the price hyperplane . Since it's a supporting hyperplane of

, and is a convex cone, the price hyperplane passes the origin. Thus
.

Since is the total profit, and every producer can at least make zero profit (that is,

), this means that the profit is exactly zero for every producer. Consequently,
every household's budget is exactly from selling endowment.

By utility maximization, every household is already doing as much as it could. Consequently,

we have .

In particular, for any coalition , and any production plan that is Pareto-better, we
have

and consequently, the point lies above the price hyperplane, making it

unattainable.

In Debreu and Scarf's paper, they defined a particular way to approach an infinitely large economy, by
"replicating households". That is, for any positive integer , define an economy where there are
households that have exactly the same consumption possibility set and preference as household .

Let stand for the consumption plan of the -th replicate of household . Define a plan to be equitable iff
for any and .

In general, a state would be quite complex, treating each replicate differently. However, core states are
significantly simpler: they are equitable, treating every replicate equally.

Proposition — Any core state is equitable.

Proof

We use the "underdog coalition".

 Consider a core state . Define average distributions .

It is attainable, so we have

Suppose there exist any inequality, that is, some , then by convexity of
preferences, we have , where is the worst-treated household of type .

Now define the "underdog coalition" consisting of the worst-treated household of each type,
and they propose to distribute according to . This is Pareto-better for the coalition, and
since is conic, we also have , so the plan is attainable.

Contradiction.

Consequently, when studying core states, it is sufficient to consider one consumption plan for each type of
households. Now, define to be the set of all core states for the economy with replicates per
household. It is clear that , so we may define the limit set of core states .

We have seen that contains the set of market equilibria for the original economy. The converse is true
under minor additional assumption:[16]

(Debreu and Scarf, 1963) — If is a polygonal cone, or if every has nonempty

interior with respect to , then is the set of market equilibria for the original economy.

The assumption that is a polygonal cone, or every has nonempty interior, is necessary to avoid
the technical issue of "quasi-equilibrium". Without the assumption, we can only prove that is contained in
the set of quasi-equilibria.

Accounting for nonconvexity

The assumption that production possibility sets are convex is a strong constraint, as it implies that there is no
economy of scale. Similarly, we may consider nonconvex consumption possibility sets and nonconvex
preferences. In such cases, the supply and demand functions may be discontinuous with
respect to price vector, thus a general equilibrium may not exist.

However, we may "convexify" the economy, find an equilibrium for it, then by the Shapley–Folkman–Starr
theorem, it is an approximate equilibrium for the original economy.

In detail, given any economy satisfying all the assumptions given, except convexity of and
, we define the "convexified economy" to be the same economy, except that

iff .
where denotes the convex hull.

With this, any general equilibrium for the convexified economy is also an approximate equilibrium for the
original economy. That is, if is an equilibrium price vector for the convexified economy, then[17]

where is the Euclidean distance, and is any upper bound on the inner radii of all
(see page on Shapley–Folkman–Starr theorem for the definition of inner radii).

The convexified economy may not

satisfy the assumptions. For example, the set
is closed, but its convex hull is not closed. Imposing the
further assumption that the convexified economy also satisfies the assumptions, we find that the original
economy always has an approximate equilibrium.

Accounting for time, space, and uncertainty

The commodities in the Arrow–Debreu model are entirely abstract. Thus, although it is typically represented
as a static market, it can be used to model time, space, and uncertainty by splitting one commodity into
several, each contingent on a certain time, place, and state of the world. For example, "apples" can be split
into "apples in New York in September if oranges are available" and "apples in Chicago in June if oranges
are not available".

Given some base commodities, the Arrow–Debreu complete market is a market where there is a separate
commodity for every future time, for every place of delivery, for every state of the world under
consideration, for every base commodity.

In financial economics the term "Arrow–Debreu" most commonly refers to an Arrow–Debreu security. A
canonical Arrow–Debreu security is a security that pays one unit of numeraire if a particular state of the
world is reached and zero otherwise (the price of such a security being a so-called "state price"). As such,
any derivatives contract whose settlement value is a function on an underlying whose value is uncertain at
contract date can be decomposed as linear combination of Arrow–Debreu securities.

Since the work of Breeden and Lizenberger in 1978,[18] a large number of researchers have used options to
extract Arrow–Debreu prices for a variety of applications in financial economics.[19]

Accounting for the existence of money

No theory of money is offered here, and it is assumed that the economy works without the help
of a good serving as medium of exchange.

— Gérard Debreu, Theory of value: An axiomatic analysis of economic equilibrium (1959)

To the pure theorist, at the present juncture the most interesting and challenging aspect of money
is that it can find no place in an Arrow–Debreu economy. This circumstance should also be of
considerable significance to macroeconomists, but it rarely is.
 — Frank Hahn, The foundations of monetary theory (1987)

Typically, economists consider the functions of money to be as a unit of account, store of value, medium of
exchange, and standard of deferred payment. This is however incompatible with the Arrow–Debreu
complete market described above. In the complete market, there is only a one-time transaction at the market
"at the beginning of time". After that, households and producers merely execute their planned productions,
consumptions, and deliveries of commodities until the end of time. Consequently, there is no use for storage
of value or medium of exchange. This applies not just to the Arrow–Debreu complete market, but also to
models (such as those with markets of contingent commodities and Arrow insurance contracts) that differ in
form, but are mathematically equivalent to it.[20]

Computing general equilibria

Scarf (1967)[21] was the first algorithm that computes the general equilibrium. See Scarf (2018)[22] and
Kubler (2012)[23] for reviews.

Number of equilibria

Certain economies at certain endowment vectors may have infinitely equilibrium price vectors. However,
"generically", an economy has only finitely many equilibrium price vectors. Here, "generically" means "on
all points, except a closed set of Lebesgue measure zero", as in Sard's theorem.[24][25]

There are many such genericity theorems. One example is the following:[26][27]

Genericity — For any strictly positive endowment distribution , and any

strictly positive price vector , define the excess demand as before.

If on all ,

is well-defined,
is differentiable,
has ,

then for generically any endowment distribution , there are only finitely
many equilibria .

Proof (sketch)

Define the "equilibrium manifold" as the set of solutions to . By Walras's law, one of
the constraints is redundant. By assumptions that has rank , no more
constraints are redundant. Thus the equilibrium manifold has dimension , which is
equal to the space of all distributions of strictly positive endowments .
 By continuity of , the projection is closed. Thus by Sard's theorem, the projection from the
equilibrium manifold to is critical on only a set of measure 0. It remains to check that
the preimage of the projection is generically not just discrete, but also finite.

See also
Model (economics)
Incomplete markets
Fisher market - a simpler market model, in which the total quantity of each product is given,
and each buyer comes only with a monetary budget.
List of asset pricing articles
Financial economics § Underlying economics

References
1. Arrow, K. J.; Debreu, G. (1954). "Existence of an equilibrium for a competitive economy".
Econometrica. 22 (3): 265–290. doi:10.2307/1907353 (https://doi.org/10.2307%2F1907353).
JSTOR 1907353 (https://www.jstor.org/stable/1907353).
2. McKenzie, Lionel W. (1954). "On Equilibrium in Graham's Model of World Trade and Other
Competitive Systems". Econometrica. 22 (2): 147–161. doi:10.2307/1907539 (https://doi.org/1
0.2307%2F1907539). JSTOR 1907539 (https://www.jstor.org/stable/1907539).
3. McKenzie, Lionel W. (1959). "On the Existence of General Equilibrium for a Competitive
Economy". Econometrica. 27 (1): 54–71. doi:10.2307/1907777 (https://doi.org/10.2307%2F19
07777). JSTOR 1907777 (https://www.jstor.org/stable/1907777).
4. For an exposition of the proof, see Takayama, Akira (1985). Mathematical Economics (https://
archive.org/details/mathematicalecon00taka) (2nd ed.). London: Cambridge University Press.
pp. 265 (https://archive.org/details/mathematicalecon00taka/page/265)–274. ISBN 978-0-521-
31498-5.
5. Düppe, Till; Weintraub, E. Roy (2014-12-31). Finding Equilibrium (https://dx.doi.org/10.1515/9
781400850129). Princeton: Princeton University Press. doi:10.1515/9781400850129 (https://
doi.org/10.1515%2F9781400850129). ISBN 978-1-4008-5012-9.
6. Starr, Ross M. (1969), "Quasi–equilibria in markets with non–convex preferences
(Appendix 2: The Shapley–Folkman theorem, pp. 35–37)", Econometrica, 37 (1): 25–38,
CiteSeerX 10.1.1.297.8498 (https://citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.297.8
498), doi:10.2307/1909201 (https://doi.org/10.2307%2F1909201), JSTOR 1909201 (https://w
ww.jstor.org/stable/1909201).
7. Starr, Ross M. (2008). "Shapley–Folkman theorem" (http://www.dictionaryofeconomics.com/ar
ticle?id=pde2008_S000107). In Durlauf, Steven N.; Blume, Lawrence E. (eds.). The New
Palgrave Dictionary of Economics. Vol. 4 (Second ed.). Palgrave Macmillan. pp. 317–318.
doi:10.1057/9780230226203.1518 (https://doi.org/10.1057%2F9780230226203.1518).
ISBN 978-0-333-78676-5.
8. Starr, Ross M. (2011). General Equilibrium Theory: An Introduction (2 ed.). Cambridge
University Press. ISBN 978-0521533867.
9. Arrow, K. J. (1962). “Lectures on the theory of competitive equilibrium.” Unpublished notes of
lectures presented at Northwestern University.
10. The restricted market technique is described in (Starr 2011), Section 18.2. The technique was
used in the original publication Arrow and Debreu (1954).
11. Uzawa, Hirofumi (1962). "Walras' Existence Theorem and Brouwer's Fixed-Point Theorem" (h
季刊 理論経
ttps://www.jstage.jst.go.jp/article/economics1950/13/1/13_1_59/_article/-char/ja/).
済学 . 13 (1): 59–62. doi:10.11398/economics1950.13.1_59 (https://doi.org/10.11398%2Fecon
omics1950.13.1_59).
12. (Starr 2011), Section 18.4
13. (Starr 2011), Chapter 19
14. Debreu, Gerard (1959-01-01). Theory of Value: An Axiomatic Analysis of Economic
Equilibrium (https://books.google.com/books?id=QkX10epC46cC). Yale University Press.
ISBN 978-0-300-01559-1.
15. Arrow, Kenneth J. (2007). General competitive analysis (http://worldcat.org/oclc/817224321).
North-Holland. ISBN 978-0-444-85497-1. OCLC 817224321 (https://www.worldcat.org/oclc/8
17224321).
16. (Starr 2011) Theorem 22.2
17. (Starr 2011), Theorem 25.1
18. Breeden, Douglas T.; Litzenberger, Robert H. (1978). "Prices of State-Contingent Claims
Implicit in Option Prices". Journal of Business. 51 (4): 621–651. doi:10.1086/296025 (https://d
oi.org/10.1086%2F296025). JSTOR 2352653 (https://www.jstor.org/stable/2352653).
S2CID 153841737 (https://api.semanticscholar.org/CorpusID:153841737).
19. Almeida, Caio; Vicente, José (2008). "Are interest rate options important for the assessment
of interest risk?" (http://www.bcb.gov.br/pec/wps/ingl/wps179.pdf) (PDF). Working Papers
Series N. 179, Central Bank of Brazil.
20. (Starr 2011) Exercise 20.15
21. Scarf, Herbert (September 1967). "The Approximation of Fixed Points of a Continuous
Mapping" (https://dx.doi.org/10.1137/0115116). SIAM Journal on Applied Mathematics. 15 (5):
1328–1343. doi:10.1137/0115116 (https://doi.org/10.1137%2F0115116). ISSN 0036-1399 (htt
ps://www.worldcat.org/issn/0036-1399).
22. Scarf, Herbert E. (2018), "Computation of General Equilibria" (https://dx.doi.org/10.1057/978-1
-349-95189-5_451), The New Palgrave Dictionary of Economics, London: Palgrave
Macmillan UK, pp. 1973–1984, doi:10.1057/978-1-349-95189-5_451 (https://doi.org/10.105
7%2F978-1-349-95189-5_451), ISBN 978-1-349-95188-8, retrieved 2023-01-06
23. Kubler, Felix (2012), "Computation of General Equilibria (New Developments)" (https://dx.doi.
org/10.1057/9781137336583.0296), The New Palgrave Dictionary of Economics, 2012
Version, Basingstoke: Palgrave Macmillan, doi:10.1057/9781137336583.0296 (https://doi.org/
10.1057%2F9781137336583.0296), ISBN 9781137336583, retrieved 2023-01-06
24. Debreu, Gérard (June 2000), "Stephen Smale and the Economic Theory of General
Equilibrium" (https://dx.doi.org/10.1142/9789812792815_0025), The Collected Papers of
Stephen Smale, World Scientific Publishing Company, pp. 243–258,
doi:10.1142/9789812792815_0025 (https://doi.org/10.1142%2F9789812792815_0025),
ISBN 978-981-02-4991-5, retrieved 2023-01-06
25. Smale, Steve (1981-01-01), "Chapter 8 Global analysis and economics" (https://www.science
direct.com/science/article/pii/S1573438281010126), Handbook of Mathematical Economics,
Elsevier, vol. 1, pp. 331–370, retrieved 2023-01-06
26. Debreu, Gérard (December 1984). "Economic Theory in the Mathematical Mode" (https://dx.d
oi.org/10.2307/3439651). The Scandinavian Journal of Economics. 86 (4): 393–410.
doi:10.2307/3439651 (https://doi.org/10.2307%2F3439651). ISSN 0347-0520 (https://www.wo
rldcat.org/issn/0347-0520). JSTOR 3439651 (https://www.jstor.org/stable/3439651).
27. (Starr 2011) Section 26.3

Further reading
 Athreya, Kartik B. (2013). "The Modern Macroeconomic Approach and the Arrow–Debreu–
McKenzie Model". Big Ideas in Macroeconomics: A Nontechnical View. Cambridge: MIT
Press. pp. 11–46. ISBN 978-0-262-01973-6.
Geanakoplos, John (1987). "Arrow–Debreu model of general equilibrium". The New
Palgrave: A Dictionary of Economics. Vol. 1. pp. 116–124.
Takayama, Akira (1985). Mathematical Economics (https://archive.org/details/mathematicalec
on00taka) (2nd ed.). London: Cambridge University Press. pp. 255 (https://archive.org/details/
mathematicalecon00taka/page/255)–284. ISBN 978-0-521-31498-5.
Düppe, Till (2012). "Arrow and Debreu de-homogenized". Journal of the History of Economic
Thought. 34 (4): 491–514. CiteSeerX 10.1.1.416.2120 (https://citeseerx.ist.psu.edu/viewdoc/s
ummary?doi=10.1.1.416.2120). doi:10.1017/s1053837212000491 (https://doi.org/10.1017%2
Fs1053837212000491). S2CID 15771197 (https://api.semanticscholar.org/CorpusID:157711
97).

External links
Notes on the Arrow–Debreu–McKenzie Model of an Economy (https://web.archive.org/web/20
060711212545/http://www.hss.caltech.edu/~kcb/Notes/Arrow-Debreu.pdf), Prof. Kim C.
Border California Institute of Technology
"The Fundamental Theorem" of Finance (https://web.archive.org/web/20070628225647/http://
www.in-the-money.com/artandpap/IV%20Fundamental%20Theorem%20-%20Part%20I.doc);
part II (https://web.archive.org/web/20070628225647/http://www.in-the-money.com/artandpap/
IV%20Fundamental%20Theorem%20-%20Part%20II.doc). Prof. Mark Rubinstein, Haas
School of Business

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