Optimality and Natural Selection in Markets

Evolutionary arguments are often used to justify the fundamental behavioral postulates of competive equilibrium. Economists such as Milton Friedman have argued that natural selection favors profit maximizing firms over firms engaging in other behaviors. Consequently, producer efficiency, and therefore Pareto efficiency, are justified on evolutionary grounds. We examine these claims in an evolutionary general equilibrium model. If the economic environment were held constant, profitable firms would grow and unprofitable firms would shrink. In the general equilibrium model, prices change as factor demands and output supply evolves. Without capital markets, when firms can grow only through retained earnings, our model verifies Friedman's claim that natural selection favors profit maximization. But we show through examples that this does not imply that equilibrium allocations converge over time to efficient allocations. Consequently, Koopmans critique of Friedman is correct. When capital markets are added, and firms grow by attracting investment, Friedman's claim may fail. In either model the long-run outcomes of evolutionary market models are not well described by conventional General Equilibrium analysis with profit maximizing firms.evolution, natural selection, equilibrium, incomplete markets

Decomposability and modularity of economic interactions

No abstract availabl

An exact solution method for binary equilibrium problems with compensation and the power market uplift problem

We propose a novel method to find Nash equilibria in games with binary decision variables by including compensation payments and incentive-compatibility constraints from non-cooperative game theory directly into an optimization framework in lieu of using first order conditions of a linearization, or relaxation of integrality conditions. The reformulation offers a new approach to obtain and interpret dual variables to binary constraints using the benefit or loss from deviation rather than marginal relaxations. The method endogenizes the trade-off between overall (societal) efficiency and compensation payments necessary to align incentives of individual players. We provide existence results and conditions under which this problem can be solved as a mixed-binary linear program. We apply the solution approach to a stylized nodal power-market equilibrium problem with binary on-off decisions. This illustrative example shows that our approach yields an exact solution to the binary Nash game with compensation. We compare different implementations of actual market rules within our model, in particular constraints ensuring non-negative profits (no-loss rule) and restrictions on the compensation payments to non-dispatched generators. We discuss the resulting equilibria in terms of overall welfare, efficiency, and allocational equity

General Equilibrium with Asymmetric Information: A Dual Approach

We study markets where the characteristics or decisions of certain agents are relevant but not known to their trading partners. Assuming exclusive trans- actions, the environment is described as a continuum economy with indivis- ible commodities. We characterize incentive constrained eÆcient allocations as solutions to linear programming problems and appeal to duality theory to demonstrate the generic existence of external e ects in these markets. Because under certain conditions such e ects may generate non-convexities, random- ization emerges as a theoretic possibility. In characterizing market equilibria we show that, consistently with the personalized nature of transactions, prices are generally non-linear in the underlying consumption. On the other hand, external e ects may have critical implications for market eÆciency. With ad- verse selection, in fact, cross-subsidization across agents with di erent private information may be necessary for optimality, and so, the market need not even achieve an incentive constrained eÆcient allocation. In contrast, for the case of a single commodity, we nd that when informational asymmetries arise after the trading period (e.g. moral hazard; ex post hidden types) external e ects are fully internalized at a market equilibrium

On the Sequential Choice of Tradable Permit Allocations

This paper investigates the sequential announcement of domestic emissions caps by regulators in a federal or international-based tradable pollution permit market for a transboundary pollutant. A leader-follower framework is used to analyse the consequences of regulators sequentially announcing domestic allocation caps. We find the sequential choice of domestic allocation caps is sub-optimal and depends on the follower's reaction to the leader's choice. Furthermore, the marginal damage and the degree to which allocations are substitutes or complements affects whether the leader changes from being a net permit buyer (seller) of permits to a seller (buyer).Initial allocation, international tradable permit market, leader-follower

The Growth and Decay of Custom: The Role of the New Institutional Economics in Economic History

Customs and institutions affect and are affected by economic relations and processes. The two-way interaction is particularly important in studying history where the scale of the temporal canvas ensures that very few variables can be treated as parametric. This paper assesses the methodology which attempts the task. In particular it examines the problem of endogenizing customs, evaluates claims for the optimality of institutions, and also comments on the interplay between structural and inertial forces. Recent work in the new institutional economics stresses structural forces, while traditional history emphasizes inertial forces, but on closer analysis these are shown to be complementary

Valuing fuel diversification in optimal investment policies for electricity generation portfolios

Optimal capacity allocation for investments in electricity generation assets can be deterministically derived by comparing technology specific long-term and short-term marginal costs. In an uncertain market environment, Mean-Variance Portfolio (MVP) theory provides a consistent framework to valuate financial risks in power generation portfolios that allows to derive the efficient fuel mix of a system portfolio with different generation technologies from a welfare maximization perspective. Because existing literature on MVP applications in electricity generation markets uses predominantly numerical methods to characterize portfolio risks, this article presents a novel analytical approach combining conceptual elements of peak-load pricing and MVP theory to derive optimal portfolios consisting of an arbitrary number of plant technologies given uncertain fuel prices. For this purpose, we provide a static optimization model which allows to fully capture fuel price risks in a mean variance portfolio framework. The analytically derived optimality conditions contribute to a much better understanding of the optimal investment policy and its risk characteristics compared to existing numerical methods. Furthermore, we demonstrate an application of the proposed framework and results to the German electricity market which has not yet been treated in MVP literature on electricity markets.power plant investments, peak load pricing, mean-variance portfolio theory, fuel mix diversification