Working Paper 393

Walras' Law and Nonoptimal Equilibria in Overlapping Generations Models

S. Rao Aiyagari

Revised June 1, 1991

This paper demonstrates a connection between failure of Walras’ Law and nonoptimal equilibria in a quite general overlapping generations model. Consider the following implication of Walras’ Law in finite economies. Suppose that all prices are positive and that all agents are on their budget lines. Then, no matter how the set of goods is partitioned, there cannot be an excess supply (in value terms) for some other set in the partition with excess demand (in value terms) for some other set in the partition. We use the Cass (1972), Benveniste (1976, 1986), Balasko and Shell (1980), and Okuno and Zilcha (1980) price characterization of optimality of equilibria in pure exchange overlapping generations models to show the following link between the above implication of Walras’ Law and optimality of a competitive equilibrium. A competitive equilibrium is nonoptimal if and only if the above implication of Walras’ Law fails in its neighborhood.

Published In: The legacy of Leon Walras (Vol. 2, 2001, pp. 496-514)
Published In: Journal of Mathematical Economics (Vol. 21, No. 4, 1992, pp. 343-361)

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