Chapter 16 Stability

The chapter is concerned with endogenous processes operating in an economy that brings equilibrium; the most famous and most discussed is the law of demand and supply. If, at prevailing market signals, there is a positive excess demand in a market price, it will rise; if there is a negative excess demand, it will fall. In a partial equilibrium framework when all other prices are held fixed, it seemed that this process would bring about equilibrium provided only that the excess demand in this market was a diminishing function of its price. The chapter discusses that there is a large class of economies that have unstable equilibria under the most popular form of the price mechanism. The chapter discusses the ArrowDebreu specifications in which goods are distinguished by physical characteristics, location, date of delivery, and state of nature. It is a commonplace that many of these goods lack markets in actual economies. It is also clear that many planned excess demands are not public knowledge and that one cannot sensibly retain the traditional price adjustment schema. An alternative is to study a sequence of short period equilibriaa procedure familiar from the theory of growth. The aim is to study convergence to long-run equilibrium whether in a deterministic or in a stochastic setting. Expectations and their formation are central to this kind of approach once durable goods and production lags are included. One is then concerned with convergence to rational expectation equilibrium.