Predetermined Prices and the Allocation of Social Risks

Costas Azariadis () and Russell Cooper

No 660, Cowles Foundation Discussion Papers from Cowles Foundation, Yale University

Abstract: We propose a Walrasian explanation for the existence of fixed prices, i.e., of trades in which either the price or the quantity exchanged do not reflect all publicly available information. Such trades result in a rigid price system that facilitates the sharing of social risks; they may also cause allocative distortions which tend to increase the equilibrium price of insurance above its actuarially fair level. The simple overlapping generations model we consider here exhibits a tradeoff between risk sharing and allocative efficiency that is familiar from the incentives literature. We demonstrate that the market for non-contingent claims is active only when the insurance "gain" from it outweighs the "cost" of allocative distortions. Fixed price equilibria are constrained optima in this essay, i.e., they cannot be dominated by an appropriately constrained central planner.

Date: 1983
Note: CFP 613.
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Published in Quarterly Journal of Economics (May 1985), 495-518

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Journal Article: Predetermined Prices and the Allocation of Social Risks (1985)
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