Price level uniformity in a random matching model with perfectly patient traders
Abstract: This paper shows that one of the defining features of Walrasian equilibrium---law of one price---characterizes equilibrium in a non-Walrasian environment of (1) random trade matching without double coincidence of wants, and (2) strategic, price-setting conduct. Money is modeled as perfectly divisible and there is no constraint on agents' money inventories. In such an environment with discounting, the endogenous heterogeneity of money balances among agents implies differences in marginal valuation of money between distinct pairs of traders, which raises the question whether decentralized trade would typically involve price dispersion. We investigate the limiting case in which agents are patient, in the sense that they have overtaking-criterion preferences over random expected-utility streams. We show that in this case the ``law of one price'' holds exactly. That is, in a stationary Markov monetary equilibrium, all transactions endogenously must occur at a single price despite the decentralized organization of exchange. The result is in the same spirit as the work of Gale (1986a, b) on bargaining and competition, although the model differs from Gale's in some significant respects.
File(s): File format is application/pdf http://www.chicagofed.org/digital_assets/publications/working_papers/2001/Wp2001-17.pdf
Provider: Federal Reserve Bank of Chicago
Part of Series: Working Paper Series
Publication Date: 2001