Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/80164
Authors: 
Tirelli, Mario
Turner, Sergio
Year of Publication: 
2007
Series/Report no.: 
Working Paper, Brown University, Department of Economics 2007-16
Abstract: 
It is known that the incompleteness of asset markets causes inefficiency in almost every equilibrium. Yet unexplored is the ”size” of this inefficiency. The size of a Pareto improvement is the total willingness to pay for it, out of current consumption. Inefficiency is the maximum size of any Pareto improving reallocation. Inefficiency of US consumption in middle age is computed to be 10-11% of total consumption in youth, for CRRA parameters 1.5-3.25, in a calibrated economy. The inefficiency of a general economy is approximated. A natural approximation, based on marginal rates of substitution (MRS), is preposterously crude in the calibrated economy, owing to a law of diminishing willingness to pay. Alternative approximations end up being functions of a classical notion, weighted social welfare maximized subject to resource constraints. They are simple, sharper in general and accurate in the calibrated economy.
Subjects: 
incomplete markets
Pareto improvement
inefficiency
willingness to pay
income mobility
income distribution
social welfare function
JEL: 
D52
D61
H11
H20
Document Type: 
Working Paper

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