Economic Theory of Organisation II

Source: Econometrica, Vol. 39, No. 4 (Jul., 1971), pp. 251-266

Published by: The Econometric Society
Stable URL: http://www.jstor.org/stable/1912451
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86 ECONOMIC THEORY OF ORGANISATION II

251

goods. The consumer is able to hold his wealth in the form of one or more of M
assets, of which one is riskless. Consumer durables are modelled as being in part
consumption goods, and in part assets.
The prices of goods are assumed independently and nonstationarily distributed, so as to allow for inflation. The real returns on the (M - 1) risky assets are
assumed to be state dependent, and the consumer is assumed to know the probability distribution of the states and also the conditional distributions of returns
given the states.
The consumer enters a period knowing the prices of the goods, and the state,
and he chooses his consumption of each of the goods, and his portfolio decision so
as to maximize his expected utility.
The problem he faces is one of dynamic stochastic programming. By using
particularfunctional forms for the indirect utility function it is possible to solve this
problem by a recursive procedure in order to arrive at optimal expenditure and
investment rules for any period t = 0, . . ., T
After we have determined the expenditure rule, we convert from the indirect
utility function to the expenditure function, and differentiate this with respect to
the price vector to arrive at the demand equation vector for goods and the services
of durables. This has a functional form which corresponds to the expenditure
function.
The demand equations for assets, and the asset component of durables come
directly from the rule for the optimum portfolio composition.

86 ECONOMIC THEORY OF ORGANISATION II

On the Motivational Stability of a Planning Procedure for Non-Classical Environments, Masahiko Aoki, Kyoto University and Harvard University
In recent years, various planning procedures have been proposed with some
desirable performance characteristics besides their convergence to an optimal
resource allocation plan [e.g., informational efficiency (Arrow-Hurwicz), feasibility of a plan constructed in finite steps (Malinvaud and Kornai) among others].
But, if we allow for the possibility of such non-classical environments as increasing
returns and externalities, it may be considered that there is a kind of trade-off
among various desirable performance characteristics. Especially, informational
efficiency as defined by Hurwicz and the self-interest of individual managers will
be in direct conflict.
In this paper, two kinds of desirable properties of a planning procedure
from the motivational point of view, that is, the consistencies of the operation
rules and a success indicator for managers, will be formulated. If a planning
procedure satisfies these two properties, then the procedure will be called
motivationally-stable. Then the two procedures that can cope with increasing
returns and externalities will be proposed. They are both motivationally-stable,
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SECOND WORLD CONGRESS

but informationally-less-efficient than the competitive procedure as proposed by

Arrow and Hurwicz.
REFERENCES
[1] AOKI, M.: Investment Planning Procedure for an Open Economy with Increasing Returns (Harvard
Economic Research Project, 1969).
[2] ARROW, K. J. AND L. HURWICZ:"Decentralization and Computation in Resource Allocation,"
in R. W. Pfouts (ed.): Essays in Economics and Econometrics (University of North Carolina Press,
1960), pp. 34-104.
[3] HURWICZ,L.: "Optimality and Informational Efficiency in Resource Allocation Processes," in
K. J. Arrow, et al. (eds.): Mathematical Methods in the Social Sciences, 1959 (Stanford University
Press, 1960), pp. 27-46.

Centralization and Decentralization of Decision-Making Mechanisms: A General

Model, Antonio Camacho, Northwestern University
A general decisiort making model is presented under which the notions
"degree of centralization" and "degree of coerciveness" can be precisely defined.
Hurwicz, in his 1959 pioneer paper on this field, "Optimality and Informational
Efficiency in Resource Allocation Processes," formalizes the notion of "information decentralization" by imposing certain conditions (regarding the domain type
of messages, etc.) that the response functions or behavior rules of the participants in
the decision making process have to satisfy. This author followed the same approach
in his 1957 paper "Externalities, Optimality and Informationally Decentralized
Resource Allocation Mechanisms."
In the present model, unlike the other two models mentioned above, a new
agent (the central agent) is introduced. The degree of centralization and the degree
of coerciveness are then defined by the relation between the behavioral rule.of the
central agent and the behavioral rules of the other participants, called in our
model the management agents.
Several examples are considered to compare the "performance" of centralized
and decentralized decision making processes. In particular a simple team model
with two management agents, a central agent, and a payoff function w =
c - k1[al - (e1 + e2)]2 - k2[a2- (e1 + e2)]2 - k(a1 - a2)2 is studied. If we
accept as a measure of the degree of externality the value of (a2w)/(aalaa2) = 2k,
it is shown that for a given "natural" structure of information and for given
"natural" behavior rules, the decentralized decision making process performs
better than the centralized one no matter how high the externality is. This example
suggests (at least under the context of our model) that, contrary to what has been
advocated in part of the economic literature, the solution to the problem of
externalities is not always "internalizing" or "centralizing."
Growth, Stability, and Disequilibrium,John Ledyard, Carnegie-Mellon University
In this paper, a disequilibrium action, informationally decentralized, economic
allocation process is presented and its performance in two classes of economic
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86

ECONOMIC THEORY OF ORGANISATION II

253

environments is discussed. The process allows trading, consumption, and production to occur even though equilibrium does not exist, as opposed to the usual
non-tatonnement process in which the only allowable disequilibrium action is
trading. The process is based on the reallocation of resources towards consumers
whose "demand prices," marginal utilities, are high and away from those whose
prices are low. Production is price directed as in the usual competitive market
process.
The environments covered are among those which can be interpreted as
optimal control problems, and the process only requires that each individual know
the current environmental conditions. (E.g., no knowledge of future technology
is necessary.) These environments are split into two classes, pure flow and
stock-flow depending on whether or not stock accumulation (i.e., investment)
is feasible.
Since it is possible for such a process to be Pareto-satisfactory only in
environments whose Pareto-optimal allocations are steady-state solutions and then
only if the initial trading rates are optimal, a slightly less restrictive performance
criterion is proposed. This requires that the process closely track the optimal path
if it starts close to it. It is shown that, in pure flow environments, if the optimal path
is not changing too rapidly then the process satisfies the above criterion. It is also
shown that, in stock-flow environments, the process will not satisfy the criterion.
In fact, there are a large number of processes which cannot track the optimal path
in stock-flow environments. This result is based on the lack of Liapunov stability
of the Euler-Lagrange equations, the first order conditions for optimal control,
and indirectly extends the results of Hahn and Kurz, on the instability of competitive (or equilibrium action) growth paths, to some types of disequilibrium
action processes.

Planning for Individual and Collective Consumption, E. Malinvaud, Institut

National de la Statistique et des Etudes Economiques
The theory of public goods should benefit much from the formal study
of planning procedures since the problem raised by collective consumption is
precisely to understand how the provision for this consumption is, or should be,
decided.
Let us consider the bipolar model in which the commodities are divided into
two groups: r collective goods (h = 1, 2 ... r) that may be used,jointly and without
any exclusion, by all individual consumers (i = 1, 2 ... m) simultaneously, n - r
private goods (h = r + 1 ... n) for which use by one consumer is exclusive of use
by another. Let the consumptions be xh and Xih for commodities in one and the
other of these two groups. Assume further that production is completely centralized
and that the n-vector y of quantities available for consumption is subject to the
constraint f(y) = 0.
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SECOND WORLD CONGRESS

Looking for "realistic" planning procedures we concentrate our attention on

those using the following "indicators" to be sent to consumers:
-for each collective good (h = 1, 2. . . r) the consumption Xh,
-for each good that is individually consumed (h = r + 1, ..., n) the
price Ph,
-for each consumer (i = 1, 2 ... m) the "income" Ri to be spent on
private goods.
Correspondingly the "proposal" of consumer i will consist of two parts:
-a demand Xih for each private good h,
-a "trade-off" coefficient 7rih = Uih/Ufl that the consumer considers as
applying between each collective good h and the "numeraire" n.
A "consumptionprogram" will appear at each stage of the process. It will be
made of the Xh indicated by the board for each collective good and of the Xih
proposed by each consumer for each private good. But this program will not
necessarily be feasible. We therefore define also, at each stage of the process, a
"consumptionplan" as being made of those values xh and Xih that would be selected
if the exchange of messages were to end at this stage.
The main point for a precise definition of the procedure concerns the revision
of indicators. We shall consider the following rules:
-collective consumption of h is increased if the sum of the individual
trade-off coefficients exceeds the substitution coefficient Oh = f Vf n;
-the total available for individual consumption of h is increased if its
price exceeds its substitution coefficient Oh (for h = r + 1 ... n - 1);
-the revision of the vector y is such that it remains on the production
frontier;
-the price of the private good h is increased if its aggregate demand
exceeds the total available for consumption;
-the revision of the indicator Ri concerning the income of consumer i
is made of two parts: a compensation for the simultaneous revision of
prices and collective consumptions, a participation to the social surplus
that appears as a result of the exchange of information.
The rule for the revision of individual incomes has been chosen in such a way
that all consumers share the burden of improving the feasibility of the "'program"
and that all simultaneously benefit from the improvement brought to the "plan."
The procedure is therefore neutral with respect to equity.
Moreover, without any restrictive assumption on the differentiable utility
functions Ui, it may be shown that, if the procedure operates continuously, it
converges locally to an optimum plan.
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DUALITY IN THE THEORY OF PRODUCTION

255

ConjugateDuality and the TranscendentalLogarithmicFunction, Laurits R.

Christensen, University of Wisconsin; Dale W. Jorgenson, Harvard University;
Lawrence J. Lau, Stanford University
This paper considers the transcendental logarithmic functional form, which
provides a valid second order approximation to an arbitrary functional form. In
particular, the C.E.S. and the Cobb-Douglas functions, as well as other lesser
known varieties, are special cases of the "Trans-Log" function.
In our application we consider both the trancendental logarithmic transformation function and the transcendental logarithmic profit function under the
assumption of constant returns to scale. Two outputs, consumption and investment, and two inputs, capital and labor, are distinguished in the empirical analysis.
The "Trans-Log" transformation function is approximated by
lnF = xo + aIlnI + cxclnC + 3KIlnK + ILlnL+ ?cAlnA
+
YAA(l A)2 + 7''(lI)2

+ 8KK(ln K)2 +

'ILL

2C(l C)2

?
(InlnIlnA

+ y(IlnIlnC

ELAln L ln A

+ yCAlnClnA

(ln L)2 + fKL ln K

bIK

In I ln K +

ClnKClnCK + 6CLlnCInL=

6IL

ln L +

EKAln K

ln A

ln I ln L

0.

where
I = quantity of investment
C = quantity of consumption

K = quantity of capital
L = quantity of labor
A = productivity index
which under the assumption of profit maximization lead to marginal productivity
conditions of the type

p,I
PKK

alnF
a lnI
-alnF

a ln K
ac + y11In
l n + ycn C+
-(K

bIK

nI +

6CKlnC

inK +
+ eKK in K
bIK

6ILln
+

L+

YIA ln A

EKLlnL+ 8KAInA

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SECOND WORLD CONGRESS

256

Similarly, the "Trans-Log" profit function is approximated by

ln(Xi + 1) - o0o+ oxilnpI + iCclnPc+ )BKlnPK +
+

7AA(ln A)2 + 2(ln

+ VIA In p, In A +

P)2
'

ILlnPL

+ (XAlnA

+ VC (ln pC)2 + yIc ln pIln pC

2

CA InpcInA

KK(ln

PK)2 +

LL (In

PL)2

+ 8KLin PKln PL + ?KAInPK lnA + rLAln PL ln A

+ aIKIlnpIln PK + 6IL ln pIln PL
+

6CK

in Pc

In PK +

5CL

In Pc In PL

where
PI = price of investment
Pc = price of consumption
PK = price of capital
PL = price of labor.

By the Shephard-Uzawa-McFadden Lemma, the optimal output supply and

input demand functions are given by equations of the type

(2P2

DIn 7t
a In PI

PI, __Dnp

PKK -mInt
a

In PK
cx1 + yII In PI + VIcIn Pc + 6IK In PK + 6IL In PL + VIAIn A

(J3K + 6IK

ln pI + 6CK ln pC + eKK ln PK + EKLln PL + EKAln A)

Equations (1) and (2) form the basis of the empirical analysis. The data used
are the aggregate U.S. annual time series data developed by Christensen and
Jorgenson. Because in the aggregate the prices and quantities of outputs and inputs
influence one another, an econometric model is specified so that appropriate
instrumental variables may be employed to obtain consistent estimates. Various
economic hypotheses such as symmetry and homogeneity as well as hypotheses
on specific functional forms are formulated and tested. It is found that while the
restrictions imposed by economic theory are true, the restrictions imposed by the
specific functional forms are false. This suggests that the "Trans-Log" function
should be employed in the absence of correct a priori information on the specific
functional form.
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EMPLOYMENT AND WAGES

257

Relative Labor Employment in Manufacturing Industries, A. A. Cook, Jr., The

Rand Corporation
Over the past two decades manufacturing output has increased significantly
with virtually no increase in the employment of production labor. During the
same period, the employment of non-production labor and capital has increased
substantially. In this paper we test the hypothesis that the increase in the employment of non-production labor relative to production labor is due to the greater
complementarity of non-production labor with capital.
The model includes a three factor production function: capital, non-production labor, and production labor.
The production function possesses non-constant elasticities of substitution.
However, the ratio of any two pairwise partial elasticities of substitution is constant
and expressible wholly in terms of the parameters of the production function.
Hence, estimation of the parameters provides a test for differing complementarity
between pairs of factors.
The estimation is essentially a two-stage process in which the three employment demand equations are estimated simultaneously and then these parameter
estimates are used in estimating the production function and the remaining
parameters. The data consists of quarterly time series observations for fourteen
two digit (SIC) manufacturing industries.
The results support the hypothesis that non-production labor and capital
are more complementary than production labor and capital.

An Example Comparing Bayesian Analogues of Full and Limited Information

Maximum Likelihood Estimators, Gordon M. Kaufman and Abba Krieger,
Massachusetts Institute of Technology
We consider the usual structural equation system By(i) + rz(i) = u(i), with

{ (i)j} a sequence of mutually independent random variables, identically normal

with mean zero and variance matrix E. In addition to time series data {(y(i),z(j))}
we have available cross-section data on individual rows of (B F). Given that the
cross-section data for row i is generated by an independent normal process with
variance proportional to aii, the iith element of E, we find the exact posterior
density for (Br) unconditional as regards i when E is (2 x 2), and when the prior
assigned to (B, F, i) is natural conjugate, Jeffery's-like, or some simple variant.
A functional equation (necessary condition) for (B*F*) to be a posterior model
value is derived. The posterior density of B unconditional as regards both r and
E is also given.
Properties of the posterior density of (BI') when the cross-section data is
independent of the time-series data are outlined.
Comparisons with a Bayesian analogue of LIMLE are made.
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The Autonomous Functioning of an Economic System, Janos Kornai and Bela

Martos,HungarianAcademyof Sciences
Analyzingthe way an economicsystem(a firmas well as a nationaleconomy)
works,a distinctioncan be madebetweenits autonomousand higherfunctioning.
This bears analogy to the working of the autonomousand the higher nervous
systemin living organisms,hence the terminologyadapted.The main featuresof
the autonomousfunctioningof the economic system are:
1. The simplicity of the informationrequiredfor making decisions. The
relativeunimportanceof price-typeinformation.
2. The simple behavioralrules which rely mostly on habits. This excludes
fundamentalchangesin technologyas well as majorinvestmentdecisions,which
are controlledby the highercontrol system.Anotherpoint of view is a problem
of restriction:the autonomousfunctioningaimsonly at the survivalof the system,
which may include a stationaryextension,in an essentiallyunchangedenvironment.Any other,morecomplexgoals appearin the highercontrolsystem.
The autonomousfunctioningof differentsystemsseems to be very similar,
whilethe higherfunctioningis fairlydiversifiedowingto political,social,historical
and otherconditions.It seemsto be hardto separatethe effectsof the autonomous
functioningin as much as they are always mixed up with the effects of higher
functioningin any moderneconomy.No empiricalevidenceas to the viabilityof
a pureautonomouseconomycan be given.Wemustrestrictourselvesto theoretical
reasoningvia simplifiedformal models.
As a firstapproximationof the problema simplemodelfor the Leontief-type
economy will be demonstrated.Simple behavioral rules are applied, where
relativechangesin productionand purchasequantitiesdependonly on changes
in producers'and consumers'own stocks, sales and consumptionquantities,
whilepricesplay no role. The analysisof the modelsprovesthat suchan economy
can surviveeven if minorouterdisturbancesoccur.
The conclusion which can be drawn is that informationabout stocks may
play a considerablepart in the control of any economic system, a much more
importantrole than is usuallyacknowledgedin the literature.

Solution of Finite Two-person Games with Incomplete Information, W. Krelle and

J. Burgermeister,Universityof Bonn
The paper suggestsa solution for finite non-cooperativetwo-persongames
with incompleteinformation.Eitherplayerbelongsto a finitenumberof "types"
which differ by their payoffs. Each player knows his own type but has only a
subjectiveprobabilitydistributionon the types of his opponent.These subjective
probabilitydistributionsare knownto both players.It will be shownin the paper
that each player has a uniquely determinedoptimal counterstrategyto each
strategyof his opponent.If thereis to be an optimalstrategyfor eachplayer,these
strategiesmustbe optimalagainsteachother;thatmeanstheymustbe equilibrium
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OPTIMAL ECONOMIC GROWTH

259

strategies in the sense of Nash. It is demonstrated by an example that there are

games without equilibrium strategies. In this case it is suggested that each player
"guesses" the choice of strategy of his opponent by forming a subjective probability
measure on the strategies of his opponent or (alternatively) by forming conditional
subjective probabilities on the sequences of moves of his opponent.

Un modele de croissance a deux variables de commande: arbitrage entre loisir et

consommation, D. Lacaze and D. Badellon, Faculte des Sciences de Paris
On aborde le probleme de l'arbitrage entre loisir et consommation par
l'etude d'un modele de croissance global oiula fonction d'utilite fair intervenir ces
deux grandeurs. Ce modele comporte un minimum de consommation par tete
variable dans le temps et une demande exogene (consommation des administrations
et investissements non productifs). Le progres technique est exogene.
Un probleme de controle optimal est ainsi defini, qui comprend une variable
d'etat (le taux de capital) et deux variables de commande (le taux d'activite et le
taux d'epargne net). Le principe du maximum permet de decrire avec precision
les trajectoires optimales en fonction des conditions initiales et finales: capital
initial, capital final et duree de la periode de developpement. On voit comment les
valeurs respectives de l'utilite marginale de la consommation, de l'utilite marginale
de loisir et du prix du capital gouvernent ces evolutions. On distingue ainsi dix
regions correspondant a difftrents comportements economiques.
Le modele a donne lieu a des applications numeriques. Pour cela, on a choise
comme fonction economique une somme ponderee de logarithmes, ce qui revient
a se donner l'elasticite entre loisir et consommation. Une methode originale de
resolution s'inspirant des resultats de la discussion mathematique a ete mise au
point. Les donnees numeriques ont ete empruntees aux etudes faites dans le cadre
du Commissariat au Plan.
On considere la famille d'evolutions optimales correspondant aux diverses
valeurs possibles du capital final. L'une de ces evolutions est reguliere et conduit
a des taux d'epargne et d'actualisation sensiblement constants apres un regime
transitoire initial: C'est cette evolution qui sera retenue.
On etudie egalement les variations de l'evolution optimale enfonction de
l'importance accordee au loisir. Ces resultats conduisent a une valeur du capital
final superieure a celle qui etait retenue jusque la, et 'a des valeurs satisfaisantes
des taux d'epargne et d'actualisation.

On the Theory of Financial Intermediation,David H. Pyle, University of California,

Berkeley
The essential characteristic of a financial intermediary is that it issues claims
on itself and uses the proceeds to purchase other financial assets. The principal
question to which the analysis in this paper is addressed is: under what circumThis content downloaded from 193.205.30.1 on Wed, 01 Jul 2015 08:50:27 UTC
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SECOND WORLD CONGRESS

stanceswoulda firmbe willingto sell a givendepositliabilityanduse the proceeds

to purchasea given type of financialasset when the yields on both the asset and
the liability are stochastic?The analysis deals with the portfolio problem in
financialintermediarieswhileabstractingfromthe importantproblemsof liquidity
and transactionsdemand.
In SectionII of the paper,a three-securitymodel of financialintermediation
is presented.It is shownthat a positiveriskpremiumon loans and a negativerisk
premiumon depositsaresufficient,butnot necessaryconditionsfor intermediation
to take place.The principalresultsof this sectionare summarizedin termsof the
propertiesof the joint distributionof loan and deposityields whichlead to intermediationwhenboth of theseyieldsaregreaterthantheyieldon a risklesssecurity.
By usinga mean-variancepreferencefunction,a specificexampleof the resultsof
SectionII is presentedin Section III.
Finally, the justificationfor a preferencefunction approachis discussed.In
particular,the role of equilibriumcapital asset prices in the intermediary's
portfoliodecisionis examined.
Producing,Storing,Transporting,andUsing Knowledge,J. Marschak,University
of California,Los Angeles
The costs and delaysinvolvedin storingand transportinga commodityare,
by and large, independentof its prospectivevalue in use and of its production
cost. Similarly,the costs and delays in retainingand communicatingknowledge
are, by and large,independentof both its usefulnessto the receiver("value"of
information)and the cost of producingit (e.g., cost of collecting data). This
justifiesthe attemptsto measurethe "volume"of information.It would roughly
correspondto the physicalvolumeor weightof goods in warehousesandin transit.
Essentially,it should measure the number of symbols necessaryto store and
transmita message.The largera collectionof symbols,the largerthe equipment
or time needed to handle them.
However(to returnto our analogy),the costs of storageand transportation
of commoditiesis not completely independentof its value in use. The more
valuablea commoditythe greaterwill profitbe affectedby breakageor leakage,
per pound or gallon. Similarly,some distortionsof messagesreducethe benefit
more than others.The code must be adjustedto a "fidelitycriterion."
Entropy formulae (in "bits" of information) approximatethe expected
numberof necessarysymbols,presupposingefficientencodingof eventsgrouped
into long sub-sequence("blocks").This is economicallyrelevantonly if events
follow in quick succession,permittingus to neglect the delays and storagecosts
causedby waitingfor the completionof each block.
The analysis is carriedby presentinga system (i.e., network or chain) of
processors,beginningwith the processingof eventsinto data, and endingwith the
processingof decoded messagesinto decisions. Each processoris characterized
by a transitionmatrix, a cost function, and a delay function. The assumption
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INPUT-OUTPUT ANALYSIS I

261

(usual in statistical decision theory) of costless and instantaneous decision making

need not be made. The user chooses the system maximizing the expected difference
between benefit (a function of the sequence of events and decisions) and total
cost-provided utility is additive in these components.

Various Turnpike Models of the Japanese Economy-Including an Extension of

ConsumptionTurnpike Theorem, Y. Murakami, K. Tokoyama, J. Tsukui, Economic Planning Agency, Japan
Following up Tsukui's pilot study in Econometrica, 1968, we have been
trying to develop various dynamic input-output models for an indicative planning
model of the Japanese economy; the models include technological substitution,
technological progress and change in final demand patterns. In the course of our
developmental efforts, we discovered some results of theoretical importance.
Among them, we shall here present the following three results, which are all
closely related to the so-called "turnpike property"
(1) Consumption turnpike property does hold, in spite of a change in the
discount rate associated with future consumption in a target function.
(2) Our simulation suggests that a concept of turnpike may be extended to
models including technological progress which may differ from industry
to industry. Any efficient paths starting from a given initial condition can
be approximated to a certain locus during most of the planning periods.
A turnpike locus is generally a curve but no longer a ray.
(3) In order to compute a switching of a turnpike due to a change in final
demand patterns, it is necessary to solve a special class of nonlinear
programming problems. It can be shown, however, that such nonlinear
programming problems can be solved as a particular kind of linear
programming or its recursion.
Computational results are shown to support each of the above three properties
and related findings. As is well known, a meaning of the turnpike property in the
theory of economic planning is that we can determine an optimal growth pattern
almost independently of our choice of final state conditions and/or specification
of target functions. Our results seem to warrant that turnpike property holds
over a wide range of multi-sectoral growth models so that computation of a
turnpike may be recommended as a reasonable approximation to any efficient
growth path in any national economic planning.

Prices, Information and Market Structure, Michael Rothschild, Harvard University

A commonplace of our experience is the variety and volatility of prices for
consumer goods. This is in striking contrast to the premises and predictions of
economic theory that in equilibrium markets sustain a single price for a single good.
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The perversity of the real world is attributed to markets being out of equilibrium
and to locational monopolies and the like which make economically different
goods out of what laymen regard as identical products. This paper argues that
it is not necessary to resort to such explanations. Rather, variable and varying
prices are to be expected in a world where consumers have limited facilities for
acquiring, storing and acting on information. Furthermore, it is doubtful that
the mere existence of large numbers of competing sellers will prevent the exploitation of limitations of consumers' ability to do comparative shopping.
Analysis of a model which incorporates these features of consumer behavior
reveals that in such a world equilibrium, in the conventional sense of constant
prices, may not exist if sellers compete with one another. For, in this model,
prices must be equilibrium points of a non-cooperative game which may have no
pure strategy equilibrium. When static equilibrium prices exist, this model gives
us some reason to doubt that perfect competition will protect the imperfect
consumer. In some cases this price may be calculated as a function of the number
of sellers in the market. Although the equilibrium price falls as the number of
competitors increases, it does not approach the competitive price as the number
of stores becomes infinite.
This paper builds on the work of Selten, Stigler, and Telser.

Procedure to Determine a Programme in an Economy where only Collective Goods

are Available, Pieter H. M. Ruys, Katholieke Hogeschool, Netherlands
In an economy are n collective (or nonexchangeable) goods producible in
various degrees of availability. The m individual agents together have to.make a
decision concerning the (relative) availability of the collective goods, which
affects an agent as a consumer (e.g. health service, transportation facilities) and
as a producer (e.g. hours working, job appointments). Every agent is supposed
to partake of the collective goods vector without being able to obtain anything
through exchange between individuals. A procedure can be developed that
determines a combination of quantities of collective goods, such that any change
in quantity causes a disequilibrium between social benefit (a function of individual
utilities) and social cost (a function of individual disutilities).
Given a vector of goods (x), every agent determines the direction of the relative
changes in the proposed vector (p) in which his utility will be maximized. Normalized to an individual "income" or influence-constraint (px < 1), p can be considered as the individual cost or benefit of the proposed vector. These are summed
to get the social cost and social benefit. If for some good in the vector the social
cost is higher (lower) than the social benefit, a new vector is proposed with less
(more) of the above mentioned good.
It can be shown that this problem is the dual of the determination of a
competitive equilibrium price in an exchange economy, where convergence is
reached through an excess demand function. The problem can be simplified by
taking a fixed social cost vector, which determines a specific supply set.
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PERFORMANCE OF ECONOMETRIC MODELS

263

UnitedKingdomShort-termMacro-economic Forecasts: an Evaluation, D. J. Smyth,

State Universityof New York at Buffalo;J. C. K. Ash, Universityof Reading

This paper examines the predictiveaccuracyof macroeconomicforecasts
made by the U.K. Treasuryand National Institute of Economic and Social
Researchfrom 1951and 1959respectively.Quantificationsof Treasuryforecasts
relateto the formulationof the annualBudget,and two sets of NationalInstitute
forecasts,publishedeach Februaryand May, are analysed.
The applicationof Theil'sinequalitycoefficientallowsboth the measurement
of overall predictiveaccuracyand the decompositionof forecastingerror into
bias, variance,and randomproportions.The accuracyof Treasuryand National
Instituteforecastsis comparedto that of four naive, extrapolative,forecasting
models. Series of predictionsand outcomes for the majorcomponentsof Total
Final Expenditureand Gross DomesticProductare examinedover time and on a
cross-sectionbasis for each year. Finally,forecastsare classifiedby whetherthey
were under-or over-estimatesof actual outcomes,and by whetherturning-point
errorswere involved.
We concludethat the predictiveaccuracyof the forecastsvariesconsiderably
betweenseriesand betweenyears.Typically,consumptionand total finalexpenditureare forecastwell, whereaspublicauthorities'currentexpenditureand exports
forecasts are relatively poor. Most forecasting error is non-systematic.The
National Institute forecasts improve markedly between February and May.
Treasuryand National Institute forecasts are superior to the naive models,
whetherthecomparisonis cross-sectionor time-series.Forecastsshowno improvement over time, nor is their accuracysubstantiallyimpairedby policy changes
subsequentto theirpublication.Actualchangesarenot markedlyunderestimated,
althoughlarge changesare underestimatedmore than small changes.Approximatelytwo-thirdsof all turningpoints are correctlyforecast.Whenturningpoint
errorsarecommitted,the forecasterstendto missactualturningpointsratherthan
to predictturningpoints whichsubsequentlydo not occur.
LandUse in a Long NarrowCity, Robert M. Solow, MassachusettsInstituteof
Technology
This paper more or less solves a problem first posed by Vickery. A city
occupiesa rectangularstrip of given length and width, sufficientlynarrowthat
only lengthwisetransportationis costly. A given fraction of the area must be
devotedto a homogeneousbusinessdistrict,the rest to a road. The problemis
to find the pattern of land use that minimizestotal transportationcost. Under
simpleassumptionsabout the patternof trafficgeneration(each unit of business
area generatestrafficwith destinationsuniformlydistributedover the business
district)and movementcosts, some qualitativepropertiesof the optimalland-use
patternare deduced. The differentialequation for the optimal pattern has no
simplesolution, but approximationsare given. The optimalroad widthis shown
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SECOND WORLD CONGRESS

264

to vanishat the city limit and then to be monotonicallyincreasingat a decreasing

rate to maximumwidth at the city center; it then diminishessymmetricallyto
vanish at the other end of the city. The effectsof variousgeneralizationsof the
assumptionsare discussed.
As a by-productof this analysis,it is shownthat for givenwidthand business
area,thereis an optimallengthfor the city. A city of optimallengthshouldhave
a road of constant width. If the city is longer than that, optimal use involves
abandonmentof part of the area; if the city is shorterthan that, the patternis as
describedearlier,and the shadow-valueof additionalland can be calculated.
As Vickreyhas pointed out, the profileof competitiveland rentsassociated
with any patternof land use dependson the pricing of transportationservices.
If, for instance,no chargeis madefor the use of a congestedroad,the accompanying rentprofilewill encouragedeviationsfrom socially-optimalland use. Similar
distortionresultsif, as is often the case, deliveredprices are uniformwithin the
city. The resultingimpulseto incorrectlanduse can be verysubstantial.
Notes on Endogenous Changes of Tastes, C. C. von Weizsacker, Heidelberg

University
The paper discussesa model in which tastes depend on past consumption.
If a long rundemandfunctioncan be defined,the questionariseshow to interpret
the "preferencestructure"correspondingto the long run demand function. A
theoremis proved which links the long run "preferencestructure"to the actual
shortrun preferences.The theoremis appliedto problemsof welfareeconomics.
It is shownthat policyconclusionsdifferfromsome of those derivedin traditional
welfareeconomics.
An Exploration in the Theory of Optimum Income Taxation, Part I, J. A. Mirrlees,

NuffieldCollege, Oxford
In a world with one commodityand labour,the populationof consumersis
supposedto have a diversityof skills. If a man works for a proportiony of the
availableworking-time,he providesan amountof usefullabourny to the economy.
The distributionof n in the populationis known, as are the productionfunction
for the economy, and the preferencesof consumers(which are identicalto one
another).Use of an incometax in the economyenablesthe Stateto imposea fixed
relationshipbetweenny and x, the man'sconsumption.The problemis to find a
consumptionfunctionx = c(ny) that will maximizea given valuationfunction,
whichis supposedto take the form of an integralof the utilitylevelsof individual
consumers.
Equationscharacterizingthe optimumconsumptionfunctionare obtained.
A rigorousproof of the generaltheoremwill be providedin Part II of the paper,
but the main lines of the argument,which employs variationalmethods, are
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INPUT-OUTPUT ANALYSIS II

265

presented here. It is shown that, under certain circumstances, although presumably

not in all, the marginal tax rate should be nonnegative, and that x and y should
depend continuously on n (for continuous distribution of skills).
The shape of the optimum tax schedule is further examined for special cases,
particularly that of the linear-logarithmic utility function. Marginal tax rates for
large n are established. Numerical results are given for some cases using a lognormal distribution of skills, with realistic values of the parameters. It is found
that marginal tax rates tend to be lower for high incomes than for smaller, although
they are also somewhat less for the lowest incomes. Overall, the average and
marginal tax rates are less than might have been expected, and the equalising
effects of the optimum tax schedules are found to be only moderate. It is also
found that virtually the whole labour force is induced to work. The results are
fairly sensitive to the amount of revenue it is right to raise through the income tax,
the degree of egalitarianism reflected in the valuation function, and the dispersion
of skills in the population. Within the framework used for the study, the broad
outlines of the conclusions are not much affected by this sensitivity.

Analysis of Price Changes by Means of Input-OutputTables, G. Szilagyi, Hungarian

Central Statistical Office
The paper presents a new system and new methods of price-statistical analyses
on national economy level. As a starting point it uses the input-output table and
the different price-indices are fitted in this scheme. In the course of these procedures
it is not the habitual price-vector but a special price matrix (P) which has been
used on the basis of the consideration that in general the output price indices of
the sectors differ according to the direction of sale.
Another starting point of the article can be found in the familiar analytical
means of price statistics, the price scissors. On the basis of price indexes ranged
according to the input-output table there are two different types of scissors formed,
namely:
(a) input price scissors, which is the ratio of the price index of input flows
between two sectors and the price index of total gross output of the purchasing
sector;
(b) the output price scissors, being the ratio of the price index of input flows
between two sectors and the price index of total gross output of the producing
sector.
The first one expresses the price changes of the input coefficients, while the
second one that of output coefficients. Even for the two types of scissors there has
been established the scheme of input-output tables resp. the matrices to be formed
with their aid.
By the inverse matrices of input-output tables it is possible to arrive at new,
cumulative price scissors, namely:
-at cumulative (total) input scissors, and,
-at cumulative (total) output scissors.
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266

SECOND WORLD CONGRESS

Throughthe uses of thesetotal scissorsand the outputpriceindicesof sectors

it is possibleto get new interindustrialprice indexes,the so called cumulativeor
total indexes,expressingtotal price-changesof directand indirectinputs.
On the basis of the well-knownrelationshipbetweenthe inversematrixand
the primaryinputand finaloutputwings,it becomespossibleto determinespecial
cumulativeprice scissors.
These latterrenderthe calculationof further,new cumulativepriceindexes
possible.These are the following:
-total price indicesof inputsof factorsof production,
-total priceindicesof finaluses, and
-final total price indices, expressingthe price changes of final uses of the
inputsof factorsproduction.

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