How Realistic is the Supply/Demand Equilibrium Story? A Simple Demonstration of False Trading and its Implications for Market Equilibrium

Abstract:     
Transactions at non-equilibrium prices are false trades. Under standard assumptions, markets without false trading produce Pareto-efficient outputs. This paper demonstrates graphically the complications created when false trades occur, showing that quantities produced deviate from Pareto-efficient quantities except under unique conditions. In a general equilibrium framework, this spills over to cause Pareto-inefficient results in other markets as well. These observations call into question the use of standard supply-and-demand equilibrium theory as a starting point for policy analysis.

Number of Pages in PDF File: 35

Keywords: Tâtonnement, False Trading, Pareto Efficiency, Convergence, Disequilibrium

JEL Classification: B41, D50

Accepted Paper Series