Notes on general equilibrium in pure exchange

economies
Econ 8102, Fall 2008, Beth Allen
Joseph Steinberg
May 12, 2009
Contents
1 Preliminaries 2
2 Preferences 2
2.1 Nonsatiation and monotonicity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.2 Convexity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.3 Continuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.4 Relationships between preorder properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.5 Utility functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
3 Demand 5
3.1 Budget set . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
3.2 Demand correspondence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.3 Aggregate excess demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
4 Existence of competitive equilibria 9
4.1 Fixed point theorems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
4.2 Very easy existence theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
4.3 Easy existence theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5 Welfare analysis 14
5.1 Pareto dominance and optimality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
5.2 First welfare theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.3 Second welfare theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
6 Core 17
7 Smooth economies 20
8 Large economies and nonconvexities 22
8.1 Types of nonconvexities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
8.1.1 Nonconvexity in preferences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
8.1.2 Nonconvexities in consumption sets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
8.2 Approximate equilibrium in large economies with nonconvex preferences . . . . . . . . . . . . 24
8.3 Economies with a continuum of traders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
8.3.1 Denition of an economy with a continuum of traders . . . . . . . . . . . . . . . . . . 24
8.3.2 Existence of competitive equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
1
1 Preliminaries
Denition 1.1. A pure exchange economy is a set of commodities 1, . . . , and a set I of consumers,
where each consumer i I is described by a preference relation _
i
on his consumption set X
i
and an initial
endowment vector e
i
X
i
. We can express the economy as c = (e
i
, _
i
)
iI
.
Unless otherwise specied, we will restrict our attention to a nite-dimentional commodity space and a
nite set of consumers. We will also generally assume that the consumption sets X
i
= R

+
. A price in this
economy is a vector p R

. We will almost always normalize prices so that p

, i.e,

k=1
p
k
= 1.
2 Preferences
Denition 2.1. A preorder _ on X is a binary relationship satisfying reexivity and transitivity, i.e.,
x _ x, x X and (x _ y && y _ z) x _ x, x, y, x X. A preorder _ is complete if x _ y, y _ x,
or both for all x, y X.
2.1 Nonsatiation and monotonicity
Denition 2.2. A preorder _ is locally nonsatiated on a set X if for all x X and all > 0, y X
such that |x y| < and y ~ x.
Denition 2.3. A preorder _ is weakly monotone on a set X if for all x, y X, y x y _ x.
Denition 2.4. A preorder _ is monotone on a set X if for all x, y X, y x y ~ x.
Denition 2.5. A preorder _ is strictly monotone on a set X if for all x, y X, (y x && y ,= x)
y ~ x.
2.2 Convexity
We will use the same types of convexity used in Debreus Theory of Value: An Axiomatix Analysis of
Economic Equilibrium. They are dened below.
Denition 2.6. A preorder _ is weakly convex on a set X if for all x, y X and [0, 1],
y _ x x + (1 )y _ x.
Denition 2.7. A preorder _ is convex on a set X if for all x, y X and (0, 1),
y ~ x x + (1 )y ~ x.
Denition 2.8. A preorder _ is strictly convex on a set X if for all x, y X and (0, 1),
(y _ x && y ,= x) x + (1 )y ~ x.
2.3 Continuity
There are two equivalent denitions of continuity for preferences.
Denition 2.9. A preorder _ is continuous on a set X if for all x X, the upper and lower countour
sets U(x) = y X : y _ x and L(x) = y X : x _ y are closed.
Denition 2.10. A preorder _ is continuous on a set X if for all x
n
and y
n
in X,
(y
n
_ x
n
, n && x
n
x && y
n
y) y _ x.
2
2.4 Relationships between preorder properties
Proposition 2.1. If a preorder _ is strictly monotone then it is monotone.
Proof. Let x, y X such that y x. Then y x and y ,= x. Since _ is strictly monotone, this implies that
y ~ x. Thus we have y x y ~ x, so _ is monotone.
Proposition 2.2. If a preorder _ is monotone then it is locally nonsatiated.
Proof. Let x X and let > 0. let e denote the unit vector in R

. Let y = x +

2

e. Then y x. Since _
is monotone, y ~ x. By construction, |y x| =

2
< . Thus _ is locally nonsatiated.
Proposition 2.3. If a preorder _ is transitive, weakly monotone, and locally nonsatiated then it is monotone.
Proof. Let x, y X such that y x. Let = miny
1
x
1
, . . . , y

. Then for all z X such that

|x z| < , y z. By local nonsatiation, z

X such that |x z

| < and z

~ x. Since y z

, weak
monotoncity implies that y _ z

. By transitivity, y ~ x. Thus _ is monotone.

Proposition 2.4. A preorder _ is weakly convex the upper contour sets U(x) = y X : y _ x are
convex for all x X.
Proof. Suppose _ is weakly convex. Let x X, let y, y

U(x) such that y

_ y, and let [0, 1]. By

weak convexity, y + (1 )y

_ y. By denition of U(x), y _ x. By transitivity, y + (1 )y

_ x, so
y + (1 )y

U(x). Thus U(x) is convex.

Now suppose that U(x) are convex for all x X. Let x, y X such that y _ x and let [0, 1].
By reexivity, x _ x, so x, y U(x). Since U(x) is convex, x + (1 )y U(x). By denition of U(x),
x +(1 )y _ x. Thus _ is weakly convex. Therefore _ is convex U(x) is convex for all x X.
Proposition 2.5. A preorder _ is weakly convex the open upper contour sets U

(x) = y X : y ~ x
are convex for all x X.
Proof. Suppose that _ is weakly convex. Let x X, let y, y

(x) such that y

_ y, and let [0, 1]. By

weak convexity, y + (1 )y

_ y. By denition of U

(x), y ~ x. Then by transitivity, y + (1 )y

~ x,
so y + (1 )y

(x). Thus U

(x) is convex.
Now suppose U

(x) are convex for all x X. Suppose for contradiction that _ is not weakly convex.
Then x, y X and (0, 1) such that x ,= y, y _ x but y+(1)x x. By transitivity, y ~ y+(1)x.
Thus x, y U

(x + (1 )y). But U

(x + (1 )y) is convex by assumption, so x + (1 )y

U

(x + (1 )y). This implies that x + (1 )y ~ x + (1 )y which is a contradiction. So _ must be

weakly convex. Therefore _ is weakly convex U

(x) are convex for all x X.

Proposition 2.6. If a preorder _ is strictly convex then it is convex.
Proof. Let x, y X such that y ~ x and x ,= y, and let (0, 1). Then y _ x and x ,= y, so strict convexity
implies that y + (1 )x ~ x. Thus we have y ~ x y + (1 )x ~ x, so _ is convex.
Proposition 2.7. If a preorder _ is convex and continuous then it is weakly convex.
Proof. Let x, y X such that y _ x and let (0, 1).
Case 1: Suppose y ~ x. Then by convexity, x + (1 )y ~ x. Then x + (1 )y _ x, so _ is weakly
convex.
Case 2: Now suppose y x. Suppose for contradiction that _ is not weakly convex, i.e., (0, 1)
such that x + (1 )y x. ??? nish this ???
Proposition 2.8. If a preorder _ is weakly convex, monotone and continuous, then it is convex.
3
Proof. Let x, y X such that y ~ x and let (0, 1). We want to show that y +(1 )x ~ x. Since _ is
weakly convex, y + (1 )x _ x. Suppose for contradiction that y + (1 )x x. Let e = (1, 1, . . . , 1).
By continuity,
1
> 0 such that y
1
e ~ x. By monotonicity,
2
> 0, x +
2
e ~ x. Then for
1
given
above and all
2
> 0, either
y
1
e _ x +
2
e ~ x
or
x +
2
e _ y
1
e ~ x.
By weak convexity,
[y
1
e] + (1 )[x +
2
e] _ x +
2
e ~ x
or
[y
1
e] + (1 )[x +
2
e] _ y
1
e ~ x.
So for
1
given above,
[y
1
e] + (1 )[x +
2
e] ~ x,
2
.
We can rewrite this as
[y + (1 )x] + [
1
+ (1 )
2
]e ~ x.
Since (0, 1) we can pick
2
such that
1
=
1

2
. Thus we have
[y + (1 )x] +
_

_
1

2
+ (1 )
2
_
e =~ x.
This simplies to
y + (1 )x ~ x.
Therefore _ is convex.
2.5 Utility functions
Denition 2.11. A function u : X R is a utility representation of a preorder _ if for all x, y X,
u(y) u(x) y _ x.
Theorem 2.1. If a preorder _ is complete, continuous and monotone then it has a continuous utility
representation.
Proof. Let _ be a complete, continous and monotone preorder on R
l
+
, and let x R
l
+
. Let e = (1, 1, . . . , 1)
R
++
. Then e R
l
+
R
+
. Choose such that e x. Since _ is monotone, e _ x. Also note that
0e x, so x _ 0e.
Dene A
+
and A

as
A
+
= R
+
: e _ x
A

= R
+
: x _ e
(1)
Since _ is continuous, A
+
and A

are closed. A
+
and 0 A

, so both sets are also nonempty. By

completeness of _,
R
+
= A
+
A

.
Since R
+
is connected, it cannot be separated into two disjoint closed sets, so A
+
A

,= . Let (x)
A
+
A

. Then (x)e x.
Now suppose that

A
+
A

such that

,= (x). Then either

> (x) or (x) >

. If the
former case is true, then since _ is monotone,

e ~ (x)e x. If the latter, then

e (x)e x. In
either case, it cannot be true that

A
+
A

. Therefore (x) is unique. Let y R

l
+
, and suppose that
y _ x. Then by denition of (x), we have
(y)e y _ x (x)e.
4
By transitivity of _, (y)e _ (x)e, and so by monotonicity of _, (y) (x).
Now suppose that (y) (x). Then by monotonicity of _, (y)e _ (x)e. By denition of (x), we
have
y (y)e _ (x)e x.
By transitivity of _, y _ x. Thus we have y _ x (y) (x), so u(x) = (x) is a utility representation
of _. Note that u : R
l
+
R
+
. For any x R
l
+
, we can write u
1
([0, (x)]) and u
1
([(x), )) as
u
1
([0, (x)]) = y R
l
+
: (x) u(y) = y R
l
+
: (x)e _ y
u
1
([(x), )) = y R
l
+
: u(y) (x) = y R
l
+
: y _ (x)e
By continuity of _, both of these sets are closed. So we have for every x R
l
+
, [0, (x)] and u
1
([0, (x)])
are closed, and [(x), ) and u
1
([(x), )) are closed. Thus by the topological denition of continuity,
u(x) = (x) is continuous. Thus we have shown that _ has a continuous utility representation.
Proposition 2.9. If _ is a lexicographic preference then _ has no utility representation.
Proof. Let _ be a lexicographic preference relation on R
2
+
and suppose for contradiction that u : X R
such that u is a utility representation of _. For each x R
+
, we can nd a rational number r(x) such that
u(x, 2) > r(x) > u(x, 1). Let x, x

R
+
such that x

> x. Then
u(x

, 2) > r(x

) > u(x

, 1) > u(x, 2) > r(x) > u(x, 1).

Thus r(x

) > r(x), so we have a one-to-one map r : R

+
Q. This is a contradiction since R
+
is uncountable
and Q is countable. Therefore _ has no utility representation.
3 Demand
3.1 Budget set
Denition 3.1. Consumer is budget set at price p and endowment e
i
is dened as
B(p, e
i
) = x X
i
: p x p e
i
.
Note that for all > 0, B(p, e
i
) = B(p, e
i
), i.e., the budget set is homogeneous of degree zero in the
price vector. Further, for all p >> 0 and e R

+
, B(p, e
i
) is nonempty (since p e
i
> 0) and compact (by
Heine-Borel).
Proposition 3.1. B(, e
i
) : X is a continuous (u.h.c. and l.h.c) correspondence for all e
i
R

+
.
Proof. Fix e
i
R

+
. By observation, B(p, e
i
) is compact for all p , i.e., B(, e
i
) is compact-valued on .
Let p
n
such that p
n
p and let x
n
X such that x
n
B(p
n
, e
i
), n. Let C = pp
n

nN
.
Since C and is bounded, C is also bounded. Since p
n
p, C is closed. By Heine-Borel, C is compact.
Then since the dot procuct is continuous,
w = max
pC
p e
i
exists. Because p
n
x
n
w, n and p
n
0, n, the sequence x
n
is bounded. This implies that there exists
a subsequence x
n
k
such that x
n
k
x. We know that x
n
k
B(p
n
k
, e
i
), n
k
. Then p
n
k
x
n
k
p
n
k
e
i
.
By continuity of the dot product, p x p e
i
. Then x B( p, e
i
). Therefore B(, e
i
) is u.h.c.
Again, let p
n
such that p
n
p . Let x B( p). We want to show that x
n
and N 0
such that x
n
x and x
n
B(p
n
, e
i
), n N.
Case 1: Suppose p x < p e
i
. Then p x p e
i
= p ( x e
i
) < 0. Construct x
n
so that x
n
= x, n.
Then x
n
x and p
n
x
n
= p
n
x. Note that p ( x e
i
) is a continous function of p. Since p ( x e
i
) < 0
and p
n
p, N > 0 such that for all n N, p
n
( x e
i
) < 0. Then for n N, p
n
x < p
n
e
i
. Since
x
n
= x, n, we have p
n
x
n
< p
n
e
i
. Thus x
n
B(p
n
, e
i
), n N. Since x
n
x B( p, e
i
), B(, e
i
) is
l.h.c. in this case.
5
Case 2: Suppose p x = p e
i
. Construct x
n
so that x
n
=
_
pnei
pn x
_
x, n. Then
p
n
x
n
= p
n

_
p
n
e
i
p
n
x
_
x =
_
p
n
e
i
p
n
x
_
p
n
x = p
n
e
i
.
Thus x
n
B(p
n
, e
i
), n. Since p
n
p and p x = p e
i
,
x
n

_
p e
i
p x
_
x = x.
Thus B(, e
i
) is l.h.c. in this case as well.
Since B(, e
i
) is u.h.c. and l.h.c., B(, e
i
) is continuous.
3.2 Demand correspondence
Denition 3.2. Consumer is demand at price p and endowment e
i
is
x
i
(p, e
i
) = x B(p, e
i
) : x _
i
y, y B(p, e
i
).
Theorem 3.1. If B(p, e
i
) is compact and _
i
is a complete and transitive preorder with upper contour sets
U
i
(x) = y X
i
: y _
i
x that are closed for all x B(p, e
i
) then demand is well-dened (nonempty).
Proof. Since B(p, e
i
) is compact and U
i
(x) are closed for all x X
i
, U
i
(x) B(p, e
i
) is also compact for all
x X
i
. By completeness and transitivity of _
i
, given any subset x
1
, . . . , x
n
B(p, e
i
), we can rearrange
the elements so that x
1
_
i
x
2
_
i
, . . . , _
i
x
n
. Then the upper contour sets of these allocations satisfy
U
i
(x
1
) U
i
(x
2
) , . . . , U
i
(x
n
). Thus
U
i
(x
1
) B(p, e
i
) U
i
(x
2
) B(p, e
i
) , . . . , U
i
(x
n
) B(p, e
i
).
By construction, x
k
U
i
(x
k
) B(p, e
i
) for all k 1, . . . , n. So U
i
(x
k
) B(p, e
i
) is nonempty and compact
for all k 1, . . . , n. Since the intersections are nested, this implies that
n
k=1
[U
i
(x
k
) B(p, e
i
)] ,= for
every nite subset x
1
, . . . , x
n
B(p, e
i
). By the nite intersection property of compact sets,
x
i
(p, e
i
) =
xB(p,ei)
[U
i
(x) B(p, e
i
)] ,= .
If the budget set is not compact, demand is often not well-dened.
Example 3.1. Let = 2, let e
i
= (1, 1) and let consumer is preferences be represented by the strictly
increasing utility function
u
i
(x, y) = log x + log y.
Let p = (0, 1). Then B(p, e
i
) = (x, y) R

+
: x [0, ), y 1. This set is obviously not bounded so
B(p, e
i
) is not compact.
Suppose that x
i
(p, e
i
) ,= , i.e., (x, y) x
i
(p, e
i
). Then u
i
(x, y) u
i
(x

, y

) for all (x

, y

) B(p, e
i
).
But (x + 1, y) B(p, e
i
) and u
i
(x + 1, y) > u
i
(x, y). This is a contradiction, so (x, y) , x
i
(p, e
i
). Therefore
x
i
(p, e
i
) = .
Proposition 3.2. If _
i
is weakly convex, then x
i
(p, e
i
) is convex.
Proof. Let x, y x
i
(p, e
i
) and suppose for contradiction that (0, 1) such that x +(1 )y , x
i
(p, e
i
).
Since p x p e
i
and p y p e
i
,
p e
i
(p x) + (1 )p y = p [x + (1 )y].
So x + (1 )y B(p, e
i
). By weak convexity of _
i
,
x + (1 )y _
i
x
i
y _
i
z, z B(p, e
i
).
This is a contradiction, so it must be that x
i
(p, e
i
) is convex.
6
Proposition 3.3. If _
i
is strictly convex, then x
i
(p, e
i
) is single-valued.
Proof. Let x x
i
(p, e
i
) and suppose for contradiction that y x
i
(p, e
i
) such that x ,= y. Since x, y
x
i
(p, e
i
), x
i
y. Let (0, 1). Since p x p e
i
and p y p e
i
,
p e
i
(p x) + (1 )p y = p [x + (1 )y].
So x +(1 )y B(p, e
i
). By strict convexity of _
i
, x + (1 )y ~
i
x. This contradicts x x
i
(p, e
i
), so
it must be that x
i
(p, e
i
) is single-valued.
Proposition 3.4. Let _
i
be a complete, continuous and monotone preorder and let e
i
R

+
. Then x
i
(, e
i
)
is a nonempty, compact-valued and u.h.c. correspondence on .
Proof. _
i
satises the assumptions of theorem 1, so it has a continuous utility representation u
i
: X R.
Then we can express demand x
i
(p, e
i
) as
x
i
(p, e
i
) = argmax
xB(p,ei)
u
i
(x).
Since e
i
R

+
, B(, e
i
) is nonempty and compact-valued on . By proposition 3.1, B(, e
i
) is continuous
on . Thus the theorem of the maximum implies that x
i
(, e
i
) is nonempty, compact-valued and u.h.c. on
.
Proposition 3.5. If _
i
is complete, continuous, monotone and strictly convex, then x
i
(p, e
i
) : X is a
continuous function of p.
Proof. By proposition 3.3, x
i
(, e
i
) is single-valued. By proposition 3.4, x
i
(, e
i
) is nonempty and u.h.c.
Therefore x
i
(, e
i
) is continuous.
Proposition 3.6. If _
i
is locally nonsatiated then p x = p e
i
, p , x x
i
(p, e
i
).
Proof. Suppose not. Then p and x x
i
(p, e
i
) such that p x ,= p e
i
. By denition of x
i
(p, e
i
),
p x p e
i
, so it must be that p x < p e
i
. Then > 0 such that for all y B

(x) (the open ball of radius

around x), p y < p e
i
. Then for all y B

(x), y B(p, e
i
). By local nonsatiation of _
i
, x

(x) such
that x

~
i
x. This contradicts x x
i
(p, e
i
), so it must be that p x = p e
i
x x
i
(p, e
i
).
Proposition 3.7. If e
i
0, e
i
,= 0, and _
i
is complete, continuous and strictly monotone, then for any
p
n
p , |x
i
(p
n
, e
i
)| .
Proof. Suppose not. Then there exists a sequence p
n
in such that p
n
p and x
i
(p
n
, e
i
) is
bounded. Construct x
n
so that x
n
x
i
(p
n
, e
i
) for all n. Then x
n
is bounded, so it has a convergent
subsequence x
n
k
, i.e., x
n
k
x X
i
. Note that since x
n
k
x
i
(p
n
k
, e
i
), x
n
k
B(p
n
k
, e
i
). Since p
n
k
,
p
n
k
0. And since e
i
0, p 0, and p ,= 0, p e
i
> 0. Thus B(p, e
i
) ,= . By continuity of the dot product,
p x = lim
n
k

(p
n
k
x
n
k
) lim
n
k

(p
n
k
e
i
) = p e
i
.
Then x B
i
(p, e
i
).
Since x
n
k
x
i
(p
n
k
, e
i
), x
n
k
_
i
y, y B(p
n
k
, e
i
). We want to show that x _
i
y, y B(p, e
i
). Let
y B(p, e
i
) and let (0, 1). Since p y p e
i
and p e
i
> 0, it must be that p (y) < p e
i
. By continuity
of the dot product, for n
k
suciently large we have p
n
k
(y) < p
n
k
e
i
, i.e., y B(p
n
k
, e
i
). We know that
x
n
k
x
i
(p
n
k
, e
i
), so it must be that x
n
k
_
i
y for n
k
suciently large. Take
n
k
(0, 1), n
k
such that

n
k
0. Then
n
k
y y. By continuity of _
i
,
x = lim
n
k
0
_
i
lim
n
k
0

n
k
y = y.
Since y B(p, e
i
) was chosen arbitrarily, we have shown that x _
i
y, y B(p, e
i
). Thus x x
i
(p, e
i
).
Since p , k 1, . . . , such that p
k
= 0. WLOG, let p
1
= 0. Let x

= x + (1, 0, . . . , 0). Then

p x

= p x p e
i
, so x

B
i
(p, e
i
) as well. By strict monotonicity of _
i
, x

~
i
x. This contradicts
x x
i
(p, e
i
). Therefore it must be that |x
i
(p
n
, e
i
)| . QED
7
Note that we need p e
i
> 0 for this proof to work. We require that e
i
0 since we dont know which
component(s) of p (the limit of p
n
) will be zero, so we need all components of the endowment to be strictly
positive. If we relaxed the assumption so that e
i
R

+
, then it would be possible that for every k such that
e
k
i
> 0, p
k
= 0. Then we would have p e
i
= 0 which would screw up the proof. For future reference, keep in
mind that as long as p e
i
> 0, the proof will go through unchanged. This will be useful in proving that the
boundary condition holds for aggregate excess demand when

iI
e
i
0 (which is weaker than assuming
that e
i
0, i I).
3.3 Aggregate excess demand
Denition 3.3. Aggregate excess demand Z :

R

is dened as
Z(p) =

iI
x
i
(p, e
i
)

iI
e
i
.
Proposition 3.8. Let _
i
be complete, continuous and monotone and let e
i
R

+
for all i. Then Z() is
nonempty, compact-valued and u.h.c. on .
Proof. By proposition 3.4, x
i
(, e
i
) is nonempty, compact-valued and u.h.c. on . Since Z() is the sum of
nonempty, compact-valued, u.h.c. correspondences minus a constant, Z() has the desired properties.
Proposition 3.9. Let _
i
be weakly convex for all i. Then Z() is convex-valued.
Proof. By proposition 3.2, x
i
(, e
i
) is convex-valued for all i. By the same reasoning as in the proof of
proposition 13, Z() is also convex-valued.
Proposition 3.10. Let _
i
be strictly convex for all i. Then Z() is single-valued.
Proof. By proposition 3.3, x
i
(, e
i
) is single-valued for all i. Thus Z() is also single-valued.
Proposition 3.11. Let _
i
be complete, continuous, monotone and strictly convex, and let e
i
R

+
for all
i. Then Z() is a continuous function on .
Proof. Follows from propositions 3.8 and 3.10.
Proposition 3.12. If _
i
is locally nonsatiated for all i, then Z(p) satises Walras law: p , pZ(p) = 0.
Proof. By proposition 3.6, p x
i
= p e
i
, i I, x
i
x
i
(p, e
i
). Thus for all x x R
n
+
: x
i
x
i
(p, e
i
),
p
_

iI
x
i

iI
e
i
_
=

iI
(p x
i
p e
i
) = 0.
Thus p Z(p) = 0.
Proposition 3.13. Z(p) is bounded from below.
Proof. This comes directly from the fact that for all i, the consumption set X
i
= R

+
. This implies that
consumers cannot have negative demand, so demand for each consumer is bounded from below by the zero
vector. Then Z(p) is bounded from below by

iI
e
i
.
Proposition 3.14. If i I such that e
i
R

+
and _
i
is complete, continuous and strictly monotone, then
Z(p) satises the boundary condition
p
n
p |Z(p)| .
Proof. Note that since

iI
e
i
0, for all p ,
0 < p
_

iI
e
i
_
=

iI
p e
i
.
Since p e
i
0, i I, this implies that j I such that p e
j
> 0. Then the conclusion follows from
proposition 3.7 applied to consumer j.
8
4 Existence of competitive equilibria
Denition 4.1. A competitive equilibrium in an economy c = (e
i
, _
i
)
iI
is a price p

and an
allocation x

= (x

i
)
iI
R
n
such that
1. x

i
X
i
for all i I.
2. x

i
x
i
(p

, e
i
) for all i I.
3.

iI
x

iI
e
i
(with equality for all p

).
Note that a competitive equilibrium need not be unique. Since B(p, e
i
) is homogeneous of degree zero in
prices, if (p

, x

) is a CE then (p

, x

) is also a CE for all > 0. Since we typically normalize prices so that

p

= p R

+
:

k=1
p
k
= 1, we will not deal with this kind of multiplicity. Existence of competitive
equilibria is an important part of general equilibrium. The next few subsections cover this topic.
4.1 Fixed point theorems
We will make use of two xed point theorems in proving the existence of competitive equilibria.
Theorem 4.1 (Brouwers xed point theorem). Let S R

be nonempty, compact and convex. If f : S S

is a continuous function, then f has a xed point; s

S such that f(s

) = s

.
Theorem 4.2 (Kakutanis xed point theorem). Let S R

be nonempty, compact and convex. If : S S

is a nonempty-valued, convex-valued and closed-graph correspondence, then has a xed point; s

S such
that s

(s

).
4.2 Very easy existence theorem
Theorem 4.3 (Very easy existence theorem). If Z :

R

is a continuous function that satises Walras

law, then p

such that Z(p

) 0. Further, Z(p

) ,= 0 only when p .
Proof. Dene G :

R

by
G(p) = (p
1
+ max0, Z
1
(p), . . . , p

+ max0, Z

(p)) .
Since Z is continuous, max0, Z
k
(p) is continuous k 1, . . . , . Dene F :



by
F(p) =
_
1

k=1
p
k
+

k=1
max0, Z
k
(p)
_
G(p).
Since p

,

k=1
p
k
= 1. Thus
F(p) =
_
1
1 +

k=1
max0, Z
k
(p)
_
G(p).
Since 1 +

k=1
max0, Z
k
(p) 1 for all p

, F is continuous.
Note that

is nonempty, compact and convex. Then since F is continuous, Brouwers xed point
theorem implies that p

such that F(p

) = p

. Then
p

=
_
1
1 +

k=1
max0, Z
k
(p

)
_
G(p

).
Let denote
1
1 +

k=1
max0, Z
k
(p

)
.
9
Then
p

= G(p

).
Note that 1 since 1 +

k=1
max0, Z
k
(p

) 1.
Suppose that < 1. Then p

G(p

), i.e.,
p

k
< p

k
+ max0, Z
k
(p

), k 1, . . . , .
Then Z
k
(p

) > 0 for all k. Since p

, this implies that p

Z(p

) > 0. This violates Walras law, so it

must be that = 1. Thus we have p

= G(p

), i.e.,
p

k
= p

k
+ max0, Z
k
(p

), k 1, . . . , .
This implies that Z
k
(p

) 0 for all k. Thus Z(p

) 0.
If p

, p
k
> 0 for all k 1, . . . , . Since Walras law implies that p

Z(p

) = 0, it must be that
Z
k
(p

) = 0 for all k (since there are no positive Z

k
to cancel out any negatives). Thus we can only have
Z
k
(p

) < 0 for some k if p

k
= 0, i.e., p

. So we have shown that p

such that Z(p

) 0, and
Z(p

) ,= 0 only if p

.
Some limitations of the very easy existence theorem:
It assumes Z is a function rather than a correspondence. This requires strictly convex preferences.
For many utility functions utility is unbounded when the price of a commodity is zero so demand might
not be well-dened on all of

(see example 1).
Demand may not be continuous.
Allows some prices to be zero: p

.
Allows Z(p

) ,= 0.
We will deal with some of these issues in the next few existence proofs.
Theorem 4.4 (Extended very easy existence theorem). Let B

be compact and convex. If :

B

is a nonempty, convex-valued, u.h.c. correspondence that satises Walras law, then p

such that
Z

0 for some Z

(p

). Further, Z(p

) ,= 0 only when p .
Proof. Dene the correspondence :

B

by
(p, Z) =
__
p
1
+ max0, Z
1

k=1
p
k
+

k=1
max0, Z
k

, . . . ,
p

+ max0, Z

k=1
p
k
+

k=1
max0, Z
k

_
, (p)
_
.
Note that
_
p
1
+ max0, Z
1

k=1
p
k
+

k=1
max0, Z
k

, . . . ,
p

+ max0, Z

k=1
p
k
+

k=1
max0, Z
k

_
is a continuous function of (p, Z). Then since is nonempty, closed-valued, convex-valued and u.h.c. by
assumption, has those properties as well. Because is closed-valued and has compact range (B

is compact),
upper hemicontinuity is equivalent to having a closed graph. Therefore has a xed point (p

, Z

), i.e.,
(p

, Z

)
__
p

1
+ max0, Z

k=1
p

k
+

k=1
max0, Z

, . . . ,
p

+ max0, Z

k=1
p

k
+

k=1
max0, Z

_
, (p

)
_
.
This implies that
p

=
_
p

1
+ max0, Z

k=1
p

k
+

k=1
max0, Z

, . . . ,
p

+ max0, Z

k=1
p

k
+

k=1
max0, Z

_
and Z

(p

). The conclusion then follows from the proof of the regular VEET.
10
4.3 Easy existence theorem
Theorem 4.5 (Easy existence theorem). Let Z : R

be a continuous function that is bounded from

below, satises Walras law, and satises the boundary condition
p
n
p |Z(p
n
)| .
Then p

such that Z(p

) = 0.
Proof. Dene the correspondence :



by
(p) =
_
q

: q argmax
q

q Z(p) if p
q

: q p = 0 if p
.
Note that

is nonempty, compact and convex. So if is nonempty-valued, convex-valued and has a closed
graph, we can use Kakutanis xed point theorem.
Nonempty-valued. If p , then since Z(p)is continuous, q Z(p) is also continuous. Since

is compact,
argmax
q

q Z(p) ,= for all p . Thus (p) ,= for all p . If p , then q such that for
each k with p
k
> 0, q
k
= 0. Thus q p = 0, so (p) ,= . Thus is nonempty-valued.
Convex-valued. Let p and let q

, q

(p). Then
q

Z(p) q Z(p), q

Z(p) q Z(p), q

.
Let [0, 1]. Then
(q

Z(p)) = (q

) Z(p) (q Z(p)), q

and
(1 )(q

Z(p)) = ((1 )q

) Z(p) (1 )(q Z(p)), q

Then
[q

+ (1 )q

] Z(p) q Z(p), q

so q

+ (1 )q

(p). Thus (p) is convex for all p .

Now let p and let q

, q

(p). Then q

p = q

p = 0. Let [0, 1]. Then

(q

p) = (q) p = 0
and
(1 )(q

p) = ((1 )q

) p = 0.
Then
[q

+ (1 )q

] p = 0
so q

+ (1 )q

(p). Thus (p) is convex for all p . Therefore (p) is convex-valued.

Closed-graph. To show that has a closed graph we must examine three separate cases.
Case 1: Let p
n


such that p
n
p . Then the rst denition of applies for p and for p
n
with n
suciently large. Since

is compact, we can think of it as a compact-valued and continuous correspondence
of p. As before, q Z(p) is a continuous function. By the theorem of the maximum, argmax
q

q Z(p) is
compact-valued and upper hemicontinuous. Note that since is compact-valued, the sequence dention of
upper hemicontinuity applies. In this case, upper hemicontinuity implies the closed graph condition: Take
p
n
p as before and q
n
(p
n
) such that q
n
q

. Upper hemicontinuity of implies that there
exists a subsequence q
n
k
q ( p). Any subsequence of a convergent sequence must converge to the same
limit as the parent sequence, so p = q. Thus q ( p), i.e., has a closed graph in this case.
Case 2: Let p
n


such that p
n
innitely often and p
n
p . Let q
n


such that
q
n
(p
n
), n and q
n
q

. Since a subsequence must converge to the same limit as the mother
11
sequence, we only need to consider the subsequence p
n
k
of p
n
such that p
n
k
for all n
k
. Then we
have q
n
k
such that q
n
k
(p
n
k
) for all n
k
. Thus q
n
k
p
n
k
= 0 for all n
k
. By continuity of the dot product,
0 = lim
n
k

(q
n
k
p
n
k
) = ( lim
n
k

q
n
k
) ( lim
n
k

p
n
k
) = q p.
Thus q ( p), so has a closed graph in this case as well.
Case 3: Let p
n


such that p
n
only nitely often and p
n
p . Let q
n


such that
q
n
(p
n
), n and q
n
q

. Again, we can just look at a subsequence p
n
k
of p
n
such that p
n
k

for all n
k
. Then since q
n
k
(p
n
k
for all n
k
,
q
n
k
Z(p
n
k
) = max
q

q Z(p
n
k
), n
k
.
Suppose for contradiction that q , ( p), i.e., q p > 0 (cannot be < 0 since q, p

R

+
). Then
j 1, . . . , such that p
j
> 0 and q
j
> 0. Since p
n
k
p, p
n
k
,j
p
j
. Then p
n
k
,j
> 0 for n
k
suciently
large. By the same logic, q
n
k
,j
> 0 for n
k
suciently large.
The boundary condition implies that |Z(p
n
k
)| since p
n
k
p . Then for n
k
large enough,
Z(p
n
k
) ,= 0. Since Z(p
n
k
) is bounded below for all n
k
, it must be that Z
i
(p
n
k
) +for some i 1, . . . , .
Since q
n
k
,j
> 0, it must be that Z
j
(p
n
k
) Z
i
(p
n
k
) for all i 1, . . . , and n
k
suciently large, i.e.,
Z
j
(p
n
k
) +. Otherwise we could nd q

with q

j
= 0 and q

Z(p
n
k
) > q
n
k
Z(p
n
k
). Since p
n
k
,j
> 0
for n
k
suciently large, Z
j
(p
n
k
) +, and Z(p
n
k
) is bounded from below, we have p
n
k
Z(p
n
k
) +.
This contradicts Walras law, so it must be that q ( p. Thus has a closed graph in all possible cases.
We have shown that

and :



satisfy the assumptions of Kakutanis xed point theorem, so
p

such that p

(p

). Note that if p then p p > 0. Then p

, so p

, i.e.,
p

Z(p

) = max
q

q Z(p

).
Suppose Z
i
(p

) > 0 for some i. Since p

, p

0. Then by the same logic as in case 3 above, the only

way that
p

Z(p

) = max
q

q Z(p

)
is if Z
i
(p

) = Z
j
(p

) for all i, j 1, . . . , , i.e., Z(p

) 0. But then p

Z(p

) > 0 which violates Walras

law. Therefore it must be that Z(p

) = 0 (note that we cannot have Z

i
(p

) < 0 for any i since this will also

violate Walras law since there are no positive Z
k
to cancel out the negatives).
Theorem 4.6 (Extended easy existence theorem). Let : R

be a nonempty, convex-valued, u.h.c.

correspondence that is bounded from below, satises Walras law, and satises the boundary condition
p
n
p |Z| , Z (p).
Then p

such that Z

= 0 for some Z

(p

).
Proof. Let B denote the lower bound for
k
, i.e., Z
k
B, k, p . Fix > 0. Dene

= p
: p
k
, k. For all p

and all Z (p), p Z = 0 by Walras law. Then for all j 1, . . . , ,

p
k
Z
k
=

j=k
p
j
Z
j
. Since Z
j
B and p
j
[, 1),

j=k
p
j
Z
j

j=k
p
j
(B) B.
This implies that p
k
Z
k
B, so Z
k

B

. Thus we have shown that for all p

and all Z (p),

Z
_
B,
B

. This means that for all p

, (p)
_
B,
B

.
Dene the correspondence

:
_
B,
B

by

(Z) = p

: p argmax
q
q Z.
12
We can think of

as a constant, continuous correspondence of Z. And q Z is a continuous function of Z,

so

is nonempty and u.h.c by the maximum theorem. To show that

is convex-valued, let p, p

(Z)
and let [0, 1]. Then for all q

, p Z q Z and p

Z q Z. Then
(p Z) + (1 )(p

Z) = (p + (1 )p

) Z q Z, q

.
Thus p + (1 )p

(Z), so

is convex-valued.
Dene the correspondence

_
B,
B

_
B,
B

by

(p, Z) = (

(Z), (p)).
Then

is the Cartesian product of two nonempty, convex-valued, u.h.c. correspondences, so

also has
those properties. And since

and
_
B,
B

are both nonempty, compact and convex,

_
B,
B

is as well. Thus Kakutanis xed point theorem applies, so

has a xed point (p

, Z

(p

, Z

).
This implies that p

(Z

) and Z

(p

). By Walras law, p

= 0. Since p

(Z

),
p

q Z

, q

. Thus
0 = p

q Z

, q

.
In particular, let q = (, , . . . , 1 ( 1)). Then
0 = p

(, , . . . , 1 ( 1)) Z

=
1

k=1
Z

,k
+ (1 ( 1))Z

k=1
(B) + (1 ( 1))Z

,
= ( 1)B + [1 ( 1)]Z

,
This implies that
( 1)B [1 ( 1)]Z

,
or
B Z

,

( 1)B
1 ( 1)
.
By similar reasoning,
B Z

,k

( 1)B
1 ( 1)
, k 1, . . . , .
Choose an arbitrary sequence
n
such that
n
. Then
p

n

n
and
B Z

n,k

( 1)
n
B
1 ( 1)
n
, k 1, . . . , .
Therefore the sequence p

n
, Z

n
is bounded, so it has a convergent subsequence p

n
k
, Z

n
k
. Then p

, Z

such that p

n
k
p

and Z

n
k
Z

. We want to show that p

, . Suppose for contradiction that

p

. Since satises the boundary condition and Z

n
k
(p

n
k
), it must be that |Z

n
k
| . But
this contradicts the fact that Z

n
is bounded. Thus p

.
Here is a summary of what we know so far.
p

n
k
p

.
Z

n
k
Z

.
13
Z

n
k
(p

n
k
).
is u.h.c.
These four facts imply that Z

(p

). Since
n
k
0, we have
(1)n
k
B
1(1)n
k
0. We also have
Z

n
k
,k

( 1)
n
k
B
1 ( 1)
n
k
, n
k
, k 1, . . . , .
Therefore Z

k
0 for all k 1, . . . , . By Walras law, p

= 0. Since p

, p

k
> 0, k. Then it
must be that Z

k
= 0 for all k 1, . . . , , i.e., Z

= 0. Thus we have shown that p

and Z

(p

)
such that Z

= 0.
5 Welfare analysis
5.1 Pareto dominance and optimality
Denition 5.1. An allocation x R
n
+
is feasible if x
i
X
i
, i I and

iI
x
i
=

iI
e
i
.
Denition 5.2. Let x, x

R
n
+
be feasible allocations. Then x weakly Pareto dominates x

if for all
i I, x
i
_
i
x

i
and j I such that x
j
~
j
x

j
.
Denition 5.3. Let x, x

R
n
+
be feasible allocations. Then x strongly Pareto dominates x

if for all
i I, x
i
~
i
x

i
.;
Note that these are partial orderings. In other words, x, x

such that x does not PD x

and vice versa.

Further, Pareto dominance is not symmetric, i.e., x cannot PD itself. It is clear that strong Pareto dominance
always implies weak Pareto dominance. What about the reverse?
Proposition 5.1. If _
i
is continuous and monotone for all i I and

iI
e
i
0, then weak Pareto
dominance is equivalent to strong Pareto dominance.
Proof. Clearly, SPD WPD. Let x, x

R
n
++
be feasible allocations and suppose that xWPDx

. Then
for all i I, x
i
_
i
x

i
, and j I such that x
j
~
j
x

j
. Since _
j
is continuous and x R
n
++
, > 0 such that
x
j
= x
j
(, , . . . , ) ~
j
x

j
.
Since _
i
is continuous i I,
x
i
= x
i
+
1
n 1
(, , . . . , ) ~
i
x

i
, i ,= j.
Then we have x
i
~
i
x

i
, i I. Since x is feasible and

iI
x
i
=

iI
x
i
, x is also feasible. Thus xSPDx

,
so given the assumptions above, WPD SPD.
Denition 5.4. A feasible allocation x R
n
+
is weakly Pareto optimal if is not strongly Pareto dominated
by any other feasible allocation.
Denition 5.5. A feasible allocation x R
n
+
is strongly Pareto optimal if is not weakly Pareto dominated
by any other feasible allocation.
Proposition 5.2. If _
i
is continuous and monotone for all i I and

iI
e
i
0, then weak Pareto
optimality is equivalent to strong Pareto optimality.
Proof. Implied by proposition 5.1.
14
5.2 First welfare theorem
There are several versions of the rst welfare theorem that use slightly dierent properties of _
i
. Here is the
rst.
Theorem 5.1 (First welfare theorem using l.n.s.). Let c = (_
i
, e
i
)
iI
be a pure exchange economy with l
goods and n traders indexed by I = 1, . . . , n, each of which having endowment e
i
R
l
+
and preferences _
i
which are complete, continuous and locally nonsatiated preorders on their respective consumption sets. Then
if (x

, p

) is a competitive equilibrium in this economy, x

is (strongly) Pareto optimal.

Proof. Let (x

, p

) be a competitive equilibrium in this economy and suppose for contradiction that x

is not
Pareto optimal. Then there exists another feasible allocation y R
ln
such that y
i
_
i
x

i
for all i 1, . . . , n
and y
j
~
j
x

j
for at least one j. Since x

j
x
j
(p

, e
j
) it must be that y
j
, B(p

, e
j
), i.e., p

y
j
> p

e
j
.
Now suppose for contradiction that for some i, p

y
i
< p

e
i
. Then y
i
B
i
(p

, e
i
). Since x

i
x
i
(p

, e
i
),
this means that x

i
_
i
y
i
, so y
i

i
x

i
. By local nonsatiation of _
i
, for all > 0 y

i
such that |y

i
y
i
| <
and y

i
~
i
y
i
. Pick small enough so that p

i
< p

e
i
. Then y

i
B
i
(p

, e
i
). But transitivity of _
i
implies
that y

i
~
i
x

i
, which contradicts the fact that x

i
x
i
(p

, e
i
). Therefore p

y
i
p

e
i
for all i.
Since p

y
i
p

e
i
for all i and p

y
j
> p

e
j
, we can see that

n
i=1
p

y
i
>

i=1
p

e
i
. Since p

,= 0,
this implies that

n
i=1
y
i
>

i=1
e
i
, so y is not feasible. This is a contradiction, so x

is Pareto optimal.
WHERE DO WE NEED CONTINUITY HERE????
Another version of the theorem relies upon monotonicity and total endowment of every commodity being
strictly positive.
Theorem 5.2 (First welfare theorem using monotonicity). Let c = (_
i
, e
i
)
iI
be a pure exchange economy
with l goods and n traders indexed by I = 1, . . . , n, each of which having endowment e
i
R
l
+
such that

iI
e
i
0, and preferences _
i
which are complete, continuous and montone preorders on their respective
consumption sets. Let (x

, p

) be a competitive equilibrium in this economy. Then if x

R
n
+
, then x

is
(strongly) Pareto optimal.
Proof. Suppose for contradiction that in some pure exchange economy c = (_
i
, e
i
)
iI
with

iI
e
i
0,
there exists a competitive equilibrium (x

, p

) such that x

R
n
+
but x

is not Pareto optimal. Then

y R
n
+
such that y is feasible, y
i
_
i
x

i
, i I, and y
j
~
j
x

j
for some j I.
Assume y
j
R

+
+ (which we can do since

iI
e
i
0). Then by continuity of _
j
, > 0 such that
y
j
= y
j
(, . . . , ) ~
j
x

j
.
By monotonicity of _
i
,
y
i
= y
i
+
_

n 1
, . . . ,

n 1
_
~
i
x

i
, i ,= j.
By construction

iI
y
i
=

iI
y
i
. Then since y is feasible, so is y. Since y
i
~
i
x

i
, i I and x

is a CE,
it must be that p

y
i
> p

e
i
, i I, i.e., y
i
is unaordable at price p

for all i. But this implies that

p

iI
y
i
= p

iI
y
i
=

iI
p

y
i
>

iI
p

e
i
= p

iI
e
i
.
But this is a contradiction, since feasibility of y and y implies that

iI
y
i
=

iI
y
i
=

iI
e
i
.
Therefore y is not feasible, so x

is Pareto optimal.
In very general terms, the FWT shows that under certain assumptions, CE PO. Note that in both
versions of the FWT, convexity of preferences is not a required assumption. Looking back at the section on
existence of competitive equilibria, all of our proofs required some kind of convexity. Thus it is important
to recognize that the FWT does not say anything about existence. In fact, one could say that in both of the
proofs above we have omitted the trivial case in which there are no competitive equilibria, i.e., CE = . Since
is a subset of every other set, in this case CE = PO. So the FWT holds even when no competitive
equilibria exist.
15
5.3 Second welfare theorem
The second welfare theorem provides a partial converse of the FWT, i.e., under certain assumptions PO
CE.
Theorem 5.3 (Second welfare theorem). Let c = (_
i
, e
i
)
iI
be a pure exchange economy with l goods
and n consumers indexed by I = 1, . . . , n, each of which having endowment e
i
R
l
+
such that

iI
e
i

0, and preferences _
i
which are complete, continuous, strictly monotone and strictly convex preorders on
their respective consumption sets. Then if x R
n
++
is a Pareto optimal allocation, then x is a compettive
equilibrium allocation when endowments are changed to e
i
= x
i
, i I. Further, x is the only CE allocation
given those endowments. Finally, the price vector p

with which x forms a CE is such that p

0 and
p

,= 0.
Proof. Since x is PO, x is feasible, so

iI
x
i
=

iI
e
i
=

iI
e
i
. Since _
i
is continuous and strictly
convex for all i I, the upper contour sets
U
i
( x
i
) = x
i
R

+
: x
i
~
i
x
i

are open in R

and strictly convex. Dene the set U as

U =

iI
U
i
( x
i
).
Then U is also open and strictly convex. Dene E as
E =

iI
x
i
.
Since x is PO, E , U. Since U is convex, there is a separating hyperplane p

such that p

,= 0 and
p

z p

E, z U.
Now we need to establish that p

is a competitive equilibrium price vector.

Step 1: (Show p

0) Let u
j
be the j-th unit basis vector in R

. By strict monotonicity of _
i
,
E +u
j
U, j. Then p

(E +u
j
E) 0, which implies that p

u
j
0, i.e., p

j
0.
Step 2: (Show x
j
~
j
x
j
p

x
j
p

x
j
) By the above hyperplane argument, if x
i
~
i
x
i
, i I, then

iI
x
i
U, so
p

iI
x
i
p

iI
x
i
.
Fix j I and assume that for some arbitrary x
j
X
j
(consumer js consumption set), x
j
~
j
x
j
. By
continuity of _
j
and the fact that x R
n
++
, > 0 such that

x
j
= x
j
(, . . . , ) ~
j
x
j
.
By monotonicity of _
i
,

x
i
= x
i
+
_

n 1
, . . . ,

n 1
_
~
i
x
i
, i ,= j.
Then

x U, so
p

iI

x
i
p

iI
x
i
.
We can rewrite this as
p

_
_
x
j
(, . . . , ) +

i=j
x
i
+

i=j
_

n 1
, . . . ,

n 1
_
_
_
p

iI
x
i
.
16
This simplies to
p

_
_
x
j
+

i=j
x
i
_
_
p

iI
x
i
.
This in turn implies that
p

x
j
p

x
j
.
Step 3: (Show x
j
~
j
x
j
p

x
j
> p

x
j
) By continuity of _
j
, (0, 1) such that x
j
~
j
x
j
. Then
by step 2,
p

(x
j
) = (p

x
j
) p

x
j
> 0
where the last part of the inequality comes from the facts that x R
n
++
, p

0, and p

,= 0. Suppose that
p

x
j
= p

x
j
. Then (p

x
j
) < p

x
j
. This is a contradiction, so it must be that p

x
j
> p

x
j
.
Let B
i
(p

, e
i
) denote consumer is budget set at price p

and endowment e
i
= x
i
. Then we have shown
that for all i I, x
i
B
i
(p

, e
i
), and x
i
~
i
x
i
implies that x
i
, B
i
(p

, e
i
). Since x is feasible, this means
that x forms a CE with price vector p

given endowments e
i
= x
i
. Further, since _
i
is strictly convex for all
i I, every consumers demand is single-valued (see proposition 12). Therefore x is the only CE allocation
at price p

. Finally, we have shown that p

0 and p

,= 0 (since its a separating hyplerlane).

6 Core
Denition 6.1. An allocation x
i
is individually rational if x
i
_
i
e
i
.
Denition 6.2. A coalition is a subset S I. If #I = n, then the total number of possible coalotions is
2
n
1.
Denition 6.3. A feasible allocation x R
n
+
is blocked by coalition S I if y R
n
+
such that

iS
y
i
=

iS
e
i
(y is feasible for S) and y
i
~
i
x
i
, i S. We call S the blocking coalition.
Denition 6.4. The core of an economy is the set of all feasible allocations that cannot be blocked by any
coalition.
Proposition 6.1. Let c be a pure exchange economy and let x Core(c). Then x is (weakly) Pareto
optimal.
Proof. Let x Core(c). Then there is no coalition S I for which there exists another feasible allocation
that strictly Pareto dominates x
i
for all i S. In particular, I itself cannot be a blocking coalition, so there
cannot be another feasible allocation y such that y
i
~
i
x
i
, i I. Then x is (weakly) Pareto optimal.
Proposition 6.2. Let c be a pure exchange economy and let x

be a competitive equilibrium allocation.

Then x

Core(c).
Proof. Suppose not. Then there exists a CE (x

, p

) such that x

, Core(c). Then a blocking coalition

S I and y R
n
+
such that

iS
y
i
=

iS
e
i
and y
i
~
i
x

i
, i S. Since x

is a CE, it must be that

p

y
i
> p

e
i
, i S. But then
p

iS
e
i
= p

iS
y
i
=

iS
p

y
i
>

iS
p

e
i
= p

iS
e
i
.
This is a contradiction, so x

Core(c). Thus CE Core.

Denition 6.5. Let c = (_
i
, e
i
)
iI
be a pure exchange economy. An R-fold replica economy
c
R
= ((_
ir
, e
ir
)
iI
)
rR

is an economy with #I types of consumers and R identical consumers of each type. In other words, _
ir
=_
is
and e
ir
= e
is
for all r, s R and all i I.
17
Theorem 6.1 (Equal treatment property). Let c = (_
i
, e
i
)
iI
be a pure exchange economy with _
i
complete, continuous, strictly monotone and strictly convex for all i I. let c
R
= ((_
ir
, e
ir
)
iI
)
rR

be the R-fold replica economy of c, with _

ir
=_
is
and e
ir
= e
is
for all rs, R and all i I. Then if
x Core(c
R
), x
ir
= x
is
for all r, s R and all i I.
Proof. Suppose not. Then i I and r R such that x
ir
,= x
is
for some s R, s ,= r. WLOG, assume that
i = 1 and for each type, the rst agent is the worst o, i.e., r = 1. Dene the coalition S as S = I 1. In
other words, S is made up of the rst agent of each type. Dene average consumption of each type as
x
i
=
1
R

rR
x
ir
.
By strict convexity of preferences, x
i
_
i
x
i1
, i I. Since s R such that x
11
,= x
1s
and x
11
_
1
x
1s
, s
R, strict convexity of prefefences implies that x
1
~
1
x
11
. Note that

iI
x
i
=

iI
1
R

rR
x
ir
=
1
R

rR

iI
x
ir
=
1
R

rR

iI
e
ir
(since x Core(c
R
), it must be feasible)
=

iI
1
R

rR
e
ir
=

iI
e
ir
=

iI
e
i1
(since all agents of the same type have the same endowment)
Then x is feasible for S.
By continuity of _
1
, x
1
~
1
x
11
implies that there exists some commodity k and > 0 such that
y
1
= x
1
u
k
~
1
x
11
where u
k
is the k-th unit basis vector in R

. By strict monotonicity of _
i
, for all i > 1,
y
i
= x
i
+

n 1
u
k
~
i
x
i1
.
Note that y is feasible for S as well:

iI
y
i
=

i=1
_
x
i
+

n 1
u
k
_
+ x
1
u
k
=

iI
x
i
=

iI
e
i1
(by the result above)
Thus we have shown that the coalition S blocks the allocation x, since there exists another allocation
y which is feasible for S and y
ir
~
i
x
ir
for all (ir) S. This contradicts the fact that x Core(c
R
), so it
must be that the equal treatment property holds.
There is also another version of the equal treatment property for convex (but not strictly convex)
preferences.
Theorem 6.2 (ETP with convex preferences). To be completed.
18
Proof. To be completed.
Theorem 6.3 (Debreu-Scarf theorem). Let c = (_
i
, e
i
)
iI
be a pure exchange economy with e
i
0
and _
i
complete, continuous, strictly monotone and strictly convex for all i I. Consider a sequence
c
R
of replica economies. Then CE =

R=1
Core(c
R
). In other words, for all R1, R2 with R2 > R1,
Core(c
R2
) Core(c
R1
).
Proof. By theorem 6.1, we know that the core of any replica economy is fully described by the core of the
economy consisting of one member of each type. This allows us to regard core allocations as vectors in R
n
+
regardless of R (the number of consumers in each type). For the rest of of the proof, we will interpret a
core allocation vector x R
n
+
as a type allocation. In other words, for all R, each consumer of type i
gets the equal treatment allocation x
i
. Note that for all R, the equal treatment allocation is feasible, since

iI
Rx
i
= R

iI
e
i
.
By proposition 6.2, we know that CE Core(c), so by the equal treatment property, CE Core(c
R
)
for all R. Thus CE

R=1
Core(c
R
). It remains to be shown that

R=1
Core(c
R
) CE. Let x

R=1
Core(c
R
), i.e., x Core(c
R
) for all R. Remember that x is a type allocation vector, so every member
of type i gets x
i
. We will argue that there exists p

such that ( x, p

) is a CE for c
R
, R, i.e.,
p

x
i
p

e
i
, i and y
i
~
i
x
i
p

y
i
> p

x
i
( x is in the budget set for each type, and any allocation
that is strictly preferred is not in the budget set).
Dene the sets U
i
( x
i
) as
U
i
( x
i
) = y
i
R

+
: y
i
+e
i
~
i
x
i
.
Let A be the convex hull of
iI
U
i
( x
i
).
Claim. A 0 = .
Proof. Suppose not. Then 0 A. By denition of a convex hull, z
i
U
i
( x
i
), i I and (
1
, . . . ,
n
) such
that
i
0,

n
i=1

i
= 1, and

n
i=1

i
z
i
= 0.
Case 1: (
i
Q) If
i
are all rational, then there are
i
, n N such that
i
=
i
n
, i. Then

iI

i
z
i
= 0.
Let R = max
iI

i
and let c
R
be the R-fold replica economy of c. Dene the allocation x by x
i
=
z
i
+e
i
, i I. Then

iI

i
x
i
=

iI
(z
i
+e
i
) =

iI

i
e
i
.
This means that the allocation x is feasible for the coalition S consisting of
i
agents of of each type i. Since
z
i
U
i
( x
i
), z
i
+ e
i
~
i
x
i
, i I. Thus the coalition S blocks the allocation x. This contradicts the fact
that x is in the core, so it must be that A 0 = .
Case 2: (
i
, Q) For each
i
we can nd a rational approximation q
n
i
Q such that q
n
i

i
. Then

iI

i
z
i
=

iI
q
n
i
_

i
q
n
i
_
z
i
= 0.
Since
_
_
_
_
i
q
n
i
_
z
i
z
i
_
_
_ 0, continuity of _
i
implies that for n suciently large,
_
i
q
n
i
_
z
i
+e
i
~
i
x
i
. Thus for
n suciently large, we can use q
n
i
in the argument used in case 1.
With this claim proved, we can go on to show the existence of a price vector with which x forms a CE.
Since 0 is a singleton it is convex, and since A is a convex hull it is convex by denition. Since A0 = ,
there exists a separating hyperplane p

,= 0 such that p

z 0, z A. Note that U
i
( x
i
) A, i, since
for any (z
i
)
iI
, we can construct a convex conmbination z =

iI

i
z
i
where
i
= 1 and
j
= 0 for j ,= i.
This implies that p

z
i
0 for all i I and all z
i
U
i
( x
i
).
First, we will show that p

x
i
= p

e
i
, i I. Let u
j
be the j-th unit basis vector in R

. By strict
monotonicity, for all i I and all > 0, x
i
+u
j
~
i
x
i
. Then x+u
j
e
i
U
i
( x
i
), so p

( x
i
+u
j
e
i
) 0.
Rewrite this as p

( x
i
+u
j
) p

e
i
. As 0, continuity of the dot product implies that p

x
i
p

e
i
.
But since

iI
x
i
=

iI
e
i
by feasibility (remmeber, all core allocations are feasible), it must be that
p

x
i
= p

e
i
, i I, i.e., x
i
B(p

, e
i
), i I.
19
The rest of the proof is similar to the proof of the SWT. We already know that x
+
u
j
e
i
U
i
( x
i
), i I.
Using the previous result,
p

( x
i
+u
j
e
i
) 0 = p

( x
i
e
i
).
This implies that p

u
j
0, i.e., p

j
0, j. Thus p

0.
Let y
i
~
i
x
i
. Then y
i
e
i
U
i
( x
i
) A, so p

(y
i
e
i
) 0, i.e., p

y
i
p

e
i
. By continuity of _
i
,
(0, 1) such that y
i
~
i
x
i
. Then y
i
U
i
( x
i
) as well, so
p

(y
i
) = (p

y
i
) p

e
i
.
Suppose that p

y
i
= p

e
i
. Then (p

y
i
) < p

e
i
, which is a contradiction. So it must be that
p

y
i
> p

e
i
. In other words, for each i I, any allocation y
i
which is strictly preferred to x
i
is not
aordable at price p

.
Thus we have shown that there exists p

+
(p

0, p

,= 0) such that for all i I, p

x
i
= p

e
i
, and
for any y
i
~
i
x
i
, p

y
i
> p

e
i
. Therefore x is a CE allocation. This implies that

R=1
Core(c
R
) CE. Since
we have also shown that CE

R=1
Core(c
R
), we now have the desired result: CE =

R=1
Core(c
R
).
The Debreu Scarf theorem. . .
7 Smooth economies
Theorem 7.1 (Sonnenscheins conjecture). Dene P

as
P

=
_
p :
p
j
p
k
, j, k
_
Let Z : P

R
n
be a continuous function that is homogeneous of degree zero and satises Walras law.
Then there is a pure exchange economy of n consumers whose aggregate demand is represented by Z on the
domain P

.
This is a somewhat negative result. It implies that one cannot always justify additional assumptions
on an economy apart from those assumptions necessary to ensure that Z is continuous, homogeneous of
degree zero and satises Walras law. This problem naturally makes one wonder how likely examples of
bad aggregate demand functions are. To examine this question we need to introduce some denitions and
technical concepts.
Denition 7.1. A smooth economy is an economy where aggregate demand Z is a smooth function,
i.e., continuously dierentiable everywhere. A sucient condition for this is that for all i, u
i
is C
2
, strictly
dierentiably monotone (Du(x) 0, x), strictly dierentiably concave (D
2
u(x) is negative denite x),
and satises the boundary condition
cly R

++
: u(y) u(x) R

++
= , x.
Denition 7.2. A manifold is a space in which every point has a neighborhood that resembles (is
homeomorphic to) Euclidean space. A manifold can be thought of as a smooth surface.
Denition 7.3. Let f : R
n
R
m
be smooth (at least C
1
).
A critical point is x R
n
such that Df(x) does not have full rank (rank m).
A regular point is x R
n
such that Df(x) has full rank (m).
A critical value is y R
m
such that y = f(x) for some critical point x.
A regular value is y R
m
such that y = f(x) for x that is not critical (note that this implies that if
y is a regular value, then all x such that f(x) = y are regular).
Note that if m > n then all points are critical. If n m, then it is easier for a point to be regular.
20
Theorem 7.2 (Regular value theorem). If y R
m
is a regular value of f, then the inverse image f
1
(y) is
a smooth manifold of dimension n m or is empty.
Theorem 7.3 (Sards theorem). Let U be an open subset of R
n
and let F : U R
m
be C
1
. Let J be the
set of critical points of F, i.e.,
J = x U : det DF(x) = 0.
Then F(J) has measure zero in R
n
.
Theorem 7.4 (Implicit function theorem). Let f : R
n+m
R
n
be C
r
. Let (x, y) R
n+m
with f(x, y) = c.
If Df
y
(x, y) is an isomorphism, then there exist neighborhoods U of x and V of y and a C
r
function g : U V
such that
g(x) = y f(x, y) = c.
In other words,
(U V ) (x, y) R
n+m
: g(x) = y = (x, y) R
n+m
: f(x, y) = c (U V ).
Theorem 7.5 (Inverse function theorem). Let M and N be smooth manifolds of the same dimension. If
F : M N is C
r
and DF(x) is an isomorphism (det DF(x) ,= 0), then F[
U
(the restriction of F on U) is
a dieomorphism (a C
r
bijection) from a neighborhood U of x to neighborhood V of F(x).
The math outline above will help us determine how common badly behaved economies are. Before we
start, we need to explicitly state which properties of an economy are desirable and which are not. First, we
want (a) the set of badly behaved economies to be of negligible size, i.e., measure zero. Second, well-behaved
economies should (b) have a discrete (or even nite) number of equilibria, i.e., for every equilibrium there
is a neighborhood in which the equilibrium is unique. Thus an economy with a continuum of equilibria is
considered to be badly-behaved. FInally, a well-behaved economy dened by endowment vector e (c) should
have equilibrium prices that depend continuously (or even continuously dierentiably) on endowments in
a neighborhood of e. In other words, the number of equilibria and their approximate values ought to be
about the same on any small neighborhood. Note that properties (a), (b) and (c) are the same as the ones
described in Regular dierentiable economies (Debreu, 1976).
Consider a smooth exchange economy with commodities and n consumers with xed preferences. The
parameters of the economy are completely described by the endowments, a vector e R
n
. Denote the set
of endowment vectors by E and note that dimE = ln. As usual, we will only consider strictly positive price
vectors. We only need 1 prices, i.e., we will consider prices as elements of
1
. Denote this set by
P and note that dimP = 1. Let

Z(e, p) be the aggregate excess demand function for the rst 1
commodities at price p and endowments e = (e
1
, . . . , e
n
). By Walras law,

Z is sucient to know aggregate
excess demand for all commodities. So an equilibrium is (e, p) such that

Z(e, p) = 0.
Let M E P be the set of pairs (e, p) such that

Z(e, p) = 0, i.e., M is the preimage of 0 under

Z.
Note that the space E P has dimension n + 1 and the equilibrium condition imposes 1 conditions
on (e, p). It can be shown that 0 is a regular value of

Z, so by the regular value theorem, M is a smooth
manifold of dimension n, i.e., the same dimension as E. We will call M the equilibrium manifold.
Dene the function T : M E as T(e, p) = e, i.e., T(e, p) is the projection of (e, p) onto E. Clearly,
T is continuously dierentiable. We will then dene a regular economy as a regular value of T. Similarly, a
critical economy is a critical value of T. By Sards theorem, the set of critical economies has measure zero,
i.e., the set of regular economies is generic. This proves property (a).
Take a regular economy e E. By denition, DT(e, p) has full rank at every point in T
1
(e), the
preimage of e under T. In other words, DT(e, p) is an isomorphism for all (e, p) T
1
(e). Let (p, e)
T
1
(e). By the inverse function theorem, there are neighborhoods U of (e, p) and V of e so that T[
U
: U V
is a dieomorphism (a C
1
bijection). This implies that T
1
(e) only has one value in U, i.e., (p, e) is the unique
equilibrium for e on U. Therefore T
1
(e) is discrete. Since we chose the regular economy e arbitrararily,
every regular economy e has a discrete set of equilibria. This proves property (b).
Take (p, e) M. Recall that

Z is C
1
and 0 is a regular value of

Z. Then DZ(p, e) is invertible for
every (p, e) M. This implies that DZ
p
(p, e) is also invertible. By the implicit function theorem, for every
(p, e) M, there are neighborhoods Y R
1
of p and X R
n
of e and a C
1
function g : X Y such
that g(e) = p if and only if

Z(p, e) = 0, i.e., (p, e) M. Thus equilibrium price systems are determined in
21
a continuous manner by endowments when working in small enough neighborhoods. This proves property
(c). Note that we dont get continuous dierentiability without the boundary condition. Explain this more
carefully. Also explain whether prices depend continuously on endowments around critical economies - seems
like they dont but I dont get why.
It can be shown that the boundary condition above strengthens (a), (b), and (c) so that (a) the set of
critical economies is closed as well as of measure zero, (b) for any regular economy e, the set of equilibrium
price-systems is nite, and (c) on a neighborhood of e this set depends in a continously dierentiable manner
on the endowments. Why?
Figure 1 shows how critical economies dier from regular economies. It shows one regular economy
(e) and two critical economies (e

, e

). The regular economy e has three equilibria, each of which depends

continuously on the endowments on a neighborhood around it. Further, on a suciently small neighborhood
around e the number of equilibria is stable. Conversely, the critical economy e

has two equilibrium price

systems, but on every neighborhood of e

, the number of price systems ranges from 1 to 3. The critical

economy e

is an example of an economy with a continuum of equilibria (as well as one islated equilibrium).
Note also that for any arbitrarily small shift to the right from e

, there is only one equilibrium, and for any

arbitrarily small shift to the left, there are only three. So e

is badly-behaved in several ways, in that it has

a continuum of equilibria and the number of equilibria is unstable on every neighborhood around it.
P
E
M
T
e
e
e

Figure 1: A graphical depiction of regular and critical economies

8 Large economies and nonconvexities
Convexity is an important assumption to many of the results discussed in previous sections. For example,
in many of our existence proofs we required preferences to be (strictly) convex so that demand, and thus,
aggregate excess demand, is single-valued. In this section, we will discuss the problems that arise from
relaxing convexity assumptions in several contexts and how we might get around them. I begin with an
example to motivate the discussion.
Example 8.1. Consider the edgeworth box in gure 2. We can see that the nonconvexity in consumer 1s
preferences prevents existence of a competitive equilibrium. However, suppose we have an economy with
two consumers of each type. If we give both consumers of type 2 the endowment e
2
(note that e = (e
1
, e
2
),
22
and give one consumer of type 1 x
1
and the other x

1
, then (x
1
, x

1
, e
2
, e
2
) is an equilibrium with the price
vector shown in the gure. This indicates that it may be possible to resolve some nonconvexity problems by
increasing the number of consumers (by creating replica economies with varying endowments).
O
1
O
2
e
x
1
x

1
_
2
_
1
Figure 2: An economy with nonconvex preferences
8.1 Types of nonconvexities
8.1.1 Nonconvexity in preferences
Convexity in preferences is required for a number of the results we proved in previous sections. Both the
very easy and easy existence theorems require strictly convex preferences so that the individuals demand,
and thus aggregate excess demand, is a single-valued (i.e., a function). The extended easy existence theorem
requires wqeakly convex preferences so that demand, and thus aggregate excess demand, is a convex-valued
correspondence. Therefore if preferences are nonconvex, there economy may have no equilibria. Convexity
is also used in the proof of the second welfare theorem to ensure that upper contour sets are convex so
that a hyperplane argument can be applied. This makes sense since the SWT is to some extent an existence
theorem. Convexity is used in a similar manner in the Debreu-Scarf theorem (also a kind of existence result).
8.1.2 Nonconvexities in consumption sets
It might also be the case that consumption sets are nonconvex. For example, we could have an economy in
which consumers are only allowed to consume whole numbers of some commodities. Intuitively, this might
represent consumption of goods like cars, houses, or as Victor suggests, spouses. This kind of nonconvexity
may be very problematic for a variety of reasons.
First, nonconvexity of consumption sets may prevent preferences from being locally nonsatiated. Suppose
that X
i
= Z

+
(the -dimensional space of non-negative integers). Then even strictly monotone preferences
like u
i
(x) =

k=1
log(x
k
) may fail to be locally non-satiated since there may be x X
i
and > such that
y X such that |x y| < . If this is the case, Walras law may not hold (see proposition 3.6). Since the
FWT and all the existence theorems rely on Walras law, most of our important results may not hold in this
situation.
Nonconvexity of consumption sets also implies that preferences are not convex: In this case, x, y X
i
does not imply that the convex combination x + (1
y
) X
i
for all (0, 1), so not all convex
combinations can be evaluated by the preferene relation _
i
(which is by denition dened on X
i
). This
may cause aggregate excess demand to be a nonconvex correspondence which will prevent us from applying
Kakutanis xed point theorem in the extended existence theorems. So in this case, existence of competitive
equilibrium may fail to hold as well.
23
8.2 Approximate equilibrium in large economies with nonconvex preferences
Suppose we have an exchange economy with I types of consumers. Suppose type i has nonconvex preferences.
Then excess demand for this type z
i
(p) is a correspondence. In a replica economy with R consumers of each
type, the average excess demand correspondence for type i is
z
R
i
(p) =
1
R
R

r=1
z
i
(p) =
1
R
z
i1
+. . . +z
iR
: z
ir
z
i
(p), r = 1, . . . , R.
Consider the economy of example 8.1 and let p = p (the price vector shown in the gure). We can see
that as R , z
R
1
( p + e
1
lls the entire segment between the points x
1
and x

1
. In particular, for any
[0, 1] and any R, we can nd an integer a
R
[0, R] such that

a
R
R

1
R
.
By putting a
R
consumers x
1
and R a
R
consumers at x

1
, we can get average consumption for type 1 of
x
R
1
=
a
R
R
x
1
+
_
1
a
R
R
_
x

1
.
By making R large enough we can get arbitrarily close to x
1
+ (1 )x

1
.
In the general case, for any p 0, z
R
i
(p) converges to the convex hull of z
i
(p) as R . To see this, let
k = #z
i
(p) and take
1
, . . . ,
k
, [0, 1] such that

k
j=1

j
= 1. For any R, we can nd integers a
1
, . . . , a
k
such that

a
j
R

j

1
R
, j = 1, . . . , k.
Thus for any convex combination of the elements of z
i
(p), we can make R large enough so that there exists
an element of z
R
i
that is arbitrarily close to the convex combination

k
j=1

j
z
j
. Therefore as R ,
the excess demand correspondence for type i will be convex-valued. This means that the aggregate excess
demand correspondence will also be convex-valued, so we will be able to apply one of the extended existence
theorems (assuming the other required assumptions hold) to get existence of an equilibrium. In this sense, as
R , the economy must have an allocation and price vector the constitute an approximate equilibrium.
For more on this, see Starr (Econometrica 37, 1969).
8.3 Economies with a continuum of traders
In all of the previous sections we assumed a nite set of traders in the economy. However, it is also possible
to work with economies in which there is a continuum of traders. In one sense, this is appropriate because
in a continuum, a single trader has measure zero, i.e., is insignicant in the aggregate. This is more or
less the case in many markets in the real world (at least on the consumption side, markets for fungible
commodities like oil are good examples). Also, the assumption of perfect competition and price taking that
we all remember from principles of micro classes requires that individual consumers have a neglibile eect on
aggregate outcomes, so a framework on which individual agents have measure zero is desirable in this sense.
8.3.1 Denition of an economy with a continuum of traders
As usual, let the commodity space be R

+
. A commodity bundle x R

+
is the same as in all of the previous
analysis. However, let the set of traders be I = [0, 1], the closed unit interval. All measure-theoretic terms
will be used in reference to I. All integrals with be respect to i so I will omit the notation di, i.e.,
_
x
means
_
x(i) di. Integrals of vector-valued functions are vector-valued as well. An allocation of commodity
bundles to traders is an integrable function mapping from I to R

+
. The endowments are now an allocation
e : I R

+
, i.e., e(i) is trader is endowment. We will assume that
_
e 0, i.e., the aggregate endowment
of each commodity is strictly positive. An allocation x is feasible if
_
x =
_
e. A price vector is still also an
element of R

+
(or normalized to

as usual). Trader is budget set is
B(i, p) = x R

+
: p x p e(i).
24
Preferences are dened more or less as before. Each trader i has a preference relation _
i
. We will assume
that _
i
is transitive, reexive, and complete for all i. We will make the following assumptions:
1. Strict monotonicity (same as usual).
2. Continuity (same as usual).
3. Measurability: For all x, y R

+
, the set i : x(i) ~
i
y(i) is measurable.
Formally, an economy in this context is c = (e(i), _
i
). A competitive equilibrium is a pair (p

, x

) such
that x

is feasible and for each trader i, x

(i) is maximal with respect to _

i
over B(i, p

), i.e.,
x

(i) x B(i, p

) : x _
i
y, y B(i, p

).
8.3.2 Existence of competitive equilibrium
Theorem 8.1 (Aumann). Let c be an economy satisfying assumptions 1 - 3. Then it has a competitive
equilibrium.
Aumann (1966) shows that under the assumptions above, the economy has a competitive equilibrium.
Note that we have not mentioned convexity of preferences at all. Intuitively, the reason is that integrating
over consumers with nonconvex demand will result in convex-valued aggregate excess demand. I will now
(very briey) outline the proof.
The rst step is to establish what Aumann calls an auxilliary theorem. We need several more assump-
tions for this step:
4. e(i) 0, i.
5. We say x saturates trader is desire if x _
i
y, y R

+
. Weaken (1) to weak desirability: unless y
saturates for trader i, x y x ~
i
y. This is similar to monotonicity.
The auxilliary theorem will actually require saturation (note that saturation is impossible under strict
monotonicity). Let v be an allocation. Trader is desire is commodity-wise-saturated at v(t) if for
all bundles x and commodities k such that x
k
v
k
(i),
x
i
(x
1
, . . . , x
k1
, v
k
(i), x
k+1
, . . . , x

).
In other words, increasing the allocation of commodity k for trader i above v
k
(i) does not change trader is
utility level. This leads to two more assumptions:
6. v : I R

+
such that each trader is desire is commodity-wise-saturated at v(i).
7. x cannot saturate for trader i unless x e(i).
Theorem 8.2 (Auxilliary theorem). Let c be an economy satisfying assumptions 2 - 7. Then c has a
competitive equilibrium.
Call the set C
p
= x R

+
: x _
i
y, y B(i, p) the preferred set for player i. The proof of
the auxilliary theorem involves showing that while the individual preferred sets are not necessarily convex
(because we have not made any assumptions about convexity of preferences), the aggregate preferred set
_
C
p
is convex.
_
C
p
represents the set of all bundles that can be distributed among the traders in such a
way that each trader is at least as satised as he is when he has a bundle in his demand correspondence.
Convexity of
_
C
p
is a direct result of the fact that I is a continuum rather than a discrete set. Proving
the theorem rigorously requires a lot of technical stu (like integration of set-valued functions) that I dont
understand or have the time to gure out.
Once the auxilliary theorem is proven, the idea is to approximate a given economy c satisfying the
assumptions of the main theorem by a sequence of economies c
n
satisfying the assumptions of the auxilliary
theorem. Each c
n
then has a competitive equilibrium (p
n
, x
n
). Aumann shows that (p
n
, x
n
) (p

, x

) that
is a CE in c.
25