Is the Market System an Efficient Bearer of Risk?

Abstract

These observations are intended as an essay, not a true research paper. They are based on recollections of research by others over many years, not documented here. These loose notes can be regarded as constituting a conceptual basis for future research (by someone); a nagging question which contains many subquestions. The market system, ideally, is efficient in allocating resources, and, in fact, in two ways. One is the one usually characterized as the workings of the invisible hand. Given the stock of resources in the economy and given the technological knowledge, the competitive market allocation is efficient in the sense of Pareto: there is no other feasible allocation which could make everyone better off. The other sense in which the market is efficient is that, in some sense, it economizes on information. In the simplest general equilibrium formulations , each individual controls certain decisions, specifically, his or her consumption bundle, sales of initial holdings of goods, and production decisions. (Consumption here includes supplies of different kinds of labour, thought of as choosing different kinds of leisure.) The information needed is his or her own preferences, holdings of goods, and production possibilities, and, in addition, some publicly available pieces of information, namely, the prices of all goods. In brief, the individual need know only information to which he or she is naturally privy (since it relates to the individual's own special aspects) plus the knowledge of prices. These characterizations are of course already problematic, even in a world of certainty. The consistency demanded of individuals is excessive according to cognitive psychologists and the behavioural