Eductive Stability in a Two Period Economy

Sayantan Ghosal

No 1994063, LIDAM Discussion Papers CORE from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: This paper examines the (local) strong rationality properties of the perfect foresight equilibrium in a two period general equilibrium model of an exchange economy with a single asset market linking the two time periods. All individuals know the model of the economy. However, they only know that period 2 prices lie in some open neighbourhood of the equilibrium price. The perfect foresight equilibrium iseductively stable or is a locally strongly rational expectations equilibrium (SREE) if by using individual optimization and market clearing all individuals are able to converge to the equilibrium price. From an eductive point of view, there are two main sources of instability: (i) the effect of a change in the amounts of the asset held across individuals on period 2 commodity prices; (ii) the effect of a change in period 2 prices on the amount of the asset held across individuals. When these effects are weak, the perfect foresight equilibrium is eductively stable or is a locally SREE.

Date: 1994-11-01
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