A general equilibrium model of a production economy with asset markets

Abstract

In this paper, a general equilibrium model of a monetary production economy is presented. The model is characterized by three classes of agents: a representative firm, heterogeneous households, and the government. Two markets (i.e., a labour market and a goods market, are considered) and two assets are traded in exchange of money, namely, government bonds and equities. Households provide the labour force and decide on consumption and savings, whereas the firm provides consumption goods and demands labour. The government receives taxes from households and pays interests on debt. The Walrasian equilibrium is derived analytically. The dynamics through quantity constrained equilibria out from the Walrasian equilibrium is also studied by means of computer simulations.

Introduction

General equilibrium theory, developed by Léon Walras in the late 19th century and later extended to include uncertainty by Arrow and Debreu in the 1950s [1], investigates the existence of equilibrium levels of production, consumption and prices in a multi-market economy. General equilibrium theory is a milestone in modern economics. However, important and unsolved problems have been arisen by economists in the past and in the recent literature. Three important criticisms regard the lack of empirical validation, the tatonnement process and the fact that the model does not encompass money. In particular, monetary policy is in general neutral in a Walrasian general equilibrium model and this fact seems to contradict empirical evidence of real world economies characterized by decentralized exchange and price setting agents. Indeed, the framework of perfectly competitive markets with price-taking agents can be considered an useful benchmark in order to compare the welfare outcomes of more realistic models characterized by imperfect competition and price rigidities along the lines of new-Keynesian economics [2]. In this respect, this study presents a general equilibrium model that includes money and two asset markets, a bond market and a stock market. An experiment of expansionary monetary policy has been performed. The model can constitute a benchmark for further research on these topics.