17 October 1983
THIS YEAR’s ECONOMICS PRIZE AWARDED FOR RESEARCH ON MARKET EQUILIBRIUM
The Royal Swedish Academy of Sciences has decided to award the 1983 Prize in Economic Sciences in Memory of Alfred Nobel to
Professor Gerard Debreu, University of California, Berkeley, USA,
for having incorporated new analytical methods into economic theory and for his rigorous reformulation of the theory of general equilibrium.
General Market Equilibrium
This year’s prize is awarded for penetrating basic research work in one of the most central fields of economic science, the theory of general equilibrium.
In a decentralized market system, individual consumers and firms make decisions on the purchase and sale of goods and services solely on the basis of self-interest. Adam Smith had already raised the question of how these decisions, apparently independent of one another, are coordinated, and result in a situation whereby sellers usually find outlets for their planned production, while consumers realize their planned consumption. Smith’s answer was that, given price and wage flexibility, price systems automatically bring about the desired coordination of individual plans. Towards the end of the 19th century, Léon Walras formulated this idea in mathematical terms as a system of equations to represent consumers’ demand for goods and services, producers’ supply of these same goods and services and their demand for factors of production, and equality between supply and demand, i.e., equilibrium in each market. But it was not until long afterward that this system of equations was scrutinized to ascertain whether it had an economically meaningful solution, i.e., whether this theoretical structure of vital importance for understanding the market system was logically consistent.
Gerard Debreu‘s major achievement is his work in proving the existence of equilibrium-creating prices. His first fundamental contribution came in the early 1950s in collaboration with Professor Kenneth Arrow. Arrow received the 1972 Prize in Economic Sciences in Memory of Alfred Nobel for his work in this and other adjacent fields.
Arrow and Debreu designed a mathematical model of a market economy where different producers planned their output of goods and services and thus also their demand for factors of production in such a way that their profit was maximized. Thus, connections were generated within the model between the supply of goods and demand for factors of production on the one hand, and all prices, on the other. By making additional assumptions about consumer behaviour, Arrow and Debreu were able to generate demand functions or “correspondences”, i.e., relations between prices and supplied and demanded quantities. In this model, Arrow and Debreu managed to prove the existence of equilibrium prices, i.e., they confirmed the internal logical consistency of Smith’s and Walras’s model of the market economy.
Subsequent to these pioneering efforts, there has been considerable development and extensions of such proofs with Gerard Debreu at the forefront. His book, Theory of Value, from the late 1950s has already become a classic both for its universality and for its elegant analytical approach. The theory developed in this study lends itself to many far-reaching interpretations and applications. The concept of “goods”, for instance, is defined so broadly that the theory may be used in pure static equilibrium analysis, the analysis of the spatial distribution of production and consumption activities, intertemporal analysis and the analysis of uncertainty. Thus, within the same model, Debreu’s general equilibrium theory integrates the theory of location, the theory of capital, and the theory of economic behaviour under uncertainty.
Efficient Resource Utilization
An essential issue which is related to the market economy and which can also be traced back to Adam Smith concerns the normative properties of the market allocation of resources. Will the fulfillment of self-interest through the “invisible hand” of the market mechanism lead to efficient utilization of scarce resources in society? Will the resources be used and production adapted so as to result in a situation where any attempt to make one individual better off necessarily means taking away from other individuals, i.e., a situation without any waste whatsoever? It has long been known that in certain circumstances, market price formation has such efficiency properties, but the exact nature and full extent of the conditions which must be satisfied in order to guarantee them had not been determined. Through the work of Debreu and his successors, these conditions have been clarified and analysed in detail.
The idea of the market economy also concerns stability of equilibrium. An interesting property of stability involves the question of whether it would be profitable for any group of market agents to withdraw completely from the market economy so as to ensure, independently, improvement of the agents’ own economic position. Debreu has made enduring contributions in this field, especially in a joint article from the early 1960s with Herbert Scarf, and through subsequent major accomplishments. He has shown that in very large economies (i.e., with numerous market agents), it will not be profitable for any group to cease trading in the markets. Hence, in this respect, the market equilibrium will be stable.
Debreu has also made significant contributions to the theory or consumer behaviour. He has indicated possible representations of consumer preferences in terms of so-called utility functions, and has also studied the feasibility of consistently aggregating individual demand functions over groups of individuals.
Debreu’s foremost contribution is perhaps of a more indirect nature, however. His clarity, analytical stringency, and insistence on always making a clear-cut distinction between a theory and its interpretation have had a profound and unsurpassed effect on the choice of methods and analytical techniques in economics.