Locally Stable Price Mechanisms

Abstract

This paper develops necessary conditions for a price adjustment mechanism to achieve local stability at regular competitive equilibria. Two principal questions are: how closely must a locally stable mechanism be tailored to particular excess demand functions, and can any such mechanism be interpreted as a market adjustment process. In response to the first question, a variant of the (local) Newton method, termed the "orthogonal Newton method" is shown to require, in a dimensional sense, the minimal information about excess demand functions. The second question is answered in the negative by proving the nonexistence of any locally stable mechanism with the property that the price of any given commodity is not changed when its own market is in equilibrium. These and other results are obtained by using convergent price paths to generate a homotopy between the adjustment dictated by the mechanism and the actual direction of the equilibrium.