CORRESPONDENCES AND FIXED POINTS Mathematics ske an addiction, ora disease: you can never truly shake it off, even if you want to. 4. Stewart (1988) concept of a function is one of the most important in mathematics and its applications. ‘A function f from a set A to a set B requires each element x of A to be mapped to exactly fone element f(x) in 8, Many economic applications require a generalized concept of function allowing any element in A to be mapped to set consisting of several elementsin B. Such "mm valued’ functions are usually called correspondences by economists. For example, suppose that p denotes a vector of parameters such as prices faced by some economic agent, Then Fp) might be the set of the agent's optimal decisions given these parameters—for example, the set of a consumer’ utility maximizing demands, or of a firm's proft maximizing production plans. Because optimal decisions may not always be unique, economists need to generalize the concept of a function inthis way. Section 14.1 studies correspondences and some of their main properties. “The maximum theorems of Section 13.4 have @ natural generalization to correspondences, Section 14,2 deals with such generalizations and also includes some economic applications. Another main focus of this chapter is on some mathematical results ofa rather deep nature ‘namely fixed point theorems. The brief Section 14.3 formulates and proves the existence of a fixed point for a special type of contraction mapping, This result has important applications to problems in the theory of differential equations, control theory and to infinite horizon dynamic programming. [Next we study the fixed point theorems of Brouwer and Kakutani, in economics these res- Llts are widely used to prove that equilibrium exists in various madels of perfectly competitive markets and in general strategic form games. These applications are regarded as major tr tumphs of mathematical economics. According to Scarf (1973), "This demonstration [of 1 existence of an equilibrium] has provided one of the rare instances in which abstract mathemat- ical techniques are indispensable in order to solve a problem of central importance to economic theory’494 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS 14.1 Correspondences ‘This section considers correspondences and in particular introduces several continuity as- sumptions that have been found useful by economists. The rather intricate relationships between these different concepts are set out in some detail DEFINITION OF CORRESPONDENCES EXAMPLE 4 Acorrespondence F from aset A into a set B is a rule that maps each x in Ato a subset F(x) of B, Then one writes F : A > Band x'++ F(x) (with double a arrows to distinguish a correspondence from 2 function). ‘The set F(x) in the definition is allowed to be empty for some elements.x in A. The domain of F is A, the set ofall x for which F(x) is defined; the effective domain is the set ofall x fn A at which F(x) is nonempty. Correspondences are also called set-valued maps or multi-valued functions. If the subset F(x) always reduces to a single point, the correspondence is effectively the same as an ordinary function. The concept of a correspondence from A © R° into O? is illustrated in Fig. 1. Fs Figure 1 F is. correspondence from A&R 10 BE (One familiar example of a correspondence is y ++ f(y) where f is an ordinary function from & to R, Recall that f~'(y) = {x : f(x) = y), which may well be empty for some x, and may contain more than one element unless / is one-to-one. Example 2.2.3 defines a consumer's budget set B(p,m) = (x ER spexsm, x20) @ for each price vector p 2 0 and income level m > 0. Thus, the budget set consists of all affordable nonnegative commodity vectors. Note that (p,m) +» 8(p,m) defines a correspondence from RI“! into BY. See Fig. 2 'EXAMPLE 2 SECTION 14.1 / CORRESPONDENCES 495 Pats Figure 2 An individuals budget corespondence when there are two commodities. Consider a firm producing a single commodity. Suppose thatthe total cost of production, as a function of output level Q, is given by o ito=o C= [F400 reg! ifQ>0 where F, a, and c are positive constants with P > a. Note that C(Q) > F whenever Q > 0, Inthis sense, F isa“fxed" or “setup” cost that must be incurred in order to produce a positive level of output Suppose the fir faces the output price P. Then its profit as a function of Qs given by _ voy f° ifO=0 oe P0-c@= {05s a0 co? ifg>0 For Q > 0, one has 2/(Q) = P — a ~ 2cQ and x”(Q) = —2c < 0. Note that 2'(Q) = 0 for 0 = Q* = (P ~ a)/2c, with x(Q*) = (P — a)?/4e ~ F. We see that 2(0") > Oif and only if (P ~ a)? > (VF), ic. if and only if P > a + 2VeF. It follows that the profit maximizing choice of output is 0 iP cat WF Ce ees a ee yielding the profit level _fo if Psa+2VeF oe { (P-a}/4e~F if P2a+2VeF Note that the producer’ behaviour is deseribed by a supply correspondence rather than a function because, when P = a + 2VcF, both 0 and /F7¢ are quantities allowing the producer fo earn zero profit. The supply correspondence is illustrated in Fig. 3 and also in Fig. 4, where the axes have been interchanged to conform with the standard convention in economies 1496 © CHAPTER 14 1 CORRESPONDENCES AND FIXED POINTS 0 / at iver on a vie a+ IVF Figure3 Figure ‘The graph of a correspondence F : A — Bis defined as graph(F) = { (x,y) € Ax Bsx@ A and y € F(x)} 8 If Fis an ordinary function, its graph reduces tothe familiar graph ofa function, Given a comespondence F : A r= B and any set $ © A, the range or the image of $ under F is defined asthe set F(S) = Uses FO) Let F be the correspondence from R to R that maps every x <1 to the interval [1, 3]. and every x > 1 to the set consisting only of the number 2. Hence _ fa, x RM and a closed set in B® x RP Figure 6 shows the graph of a correspondence F : (a, ] -» R which does have the closed graph property. Itis clear from Fig. 5 thatthe correspondence F in Example 3 does not have the closed graph property Sappose that g : R"+" — fis a continuous function, For all xin R, define PO) = (y ER": gy) <0} Show that the correspondence x» P(x) has the closed graph property. Solution: The domain of the correspondence is closed, The graph of the comespond- ence is the set ¢-!(—o0,0] = ((x,y) : g(x.¥) < 0). Because (~00, 0] is closed and g is continuous, this inverse image is closed. But then x +» (x) has the closed graph property, '498 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS Lower Hemicontinuity ‘Another frequently encountered continuity condition for correspondences isthe following: LOWER HEMICONTINUOUS CORRESPONDENCE —~ EXAMPLE 5 A correspondence F : X © &" —» RM is lower hemicontinuous (or Lh.c.) at & point x° in X if whenever y° ¢ F(x®) and (x.} is sequence in X that converges to x!, there exist a number ky and a sequence [yi}%2,, in " that converges to. (3) 1 and satisfies yk € F(X) for all k > ko, F is lower hemicontinuous (or Lh.) in X if itis Lh. at every point x in X. Lower hemicontinuity requires a correspondence to be continuous in a sense that is almost the opposite ofthe closed graph property. For example, the correspondence shown in Fi. 5 is lower hemicontinnous, but does not have the closed graph property. But the opposite hholds for the correspondence in Fig. 6. (To see why the correspondence in Fig. 6 is not lower hemicontinuous, consider the point P on the graph, and let the sequence {x4} be as suggested by the dotsin the figure. In particular, suppose [xa} converges tox. Itis obviously impossible to choose a sequence J € F (x4) that converges toy, because the corresponding sequence (1%, yx)} ean only converge to a point on the line segment RQ, and not to P.) Roughly speaking, if a correspondence F bas the closed graph property at point x° of its domain, then F(x) cannot “explode” as x moves slightly away from x°, as happens at x = Jin Fig. §, but it may “implode”, as happens atx in Fig 6. For lower hemicontinuous correspondences the opposite is true: F(x) cannot implode as x moves slightly away from x", bat it may explode, Let g = (gi.--,8)) : RX" > RI be continuous, let b be & given -vector, let A be a given closed set in R™, and let X be a given set in R". For each x in X, define the set POR) SR" by PR) = (YEA TERY Sb) =(YEArAaM Shih) 6 Show thatthe correspondence x +» JP(x) has the closed graph property. Show that it is also lower hemicontinuous if P(x) = PCR) for every x in X, where P°(x) = (y € A BY) < byt n. Solution: Proof of the closed graph property: Assume that xx > x° € X and ye —> y? when k > 00, where yj € P(X) forall &. Then yj € A and g(x. 94) = b. Because A is closed, y° € A. By continuity of g, leting k > 90 in the inequality yields g(x°, y®) < b. Ie follows that y° € P(x"), Proof of lower hemicontinuity: Let y © P(x) and let x, > x € X. Because P(x) = ‘PPG, there exist vectors y! in P*(x) such that lly! — yf) < 1/j. Because g(x,y?) < by for i = 1, ..., 1; there exists a stictly increasing sequence of numbers k; such that for > ky, the inequality g(x,y) < by holds for alli. Let yg = y! for kk < ky1- Then yi belongs to P(x) for k > ki, and lye ~ ylh = 1// for k = ky, hence yk > y. 1SECTION 14.1 / CORRESPONDENCES 499 . EXAMPLE.6 Show thatthe budget correspondence B(p, m) defined in Example 1 has he closed graph property and is lower hemicontinuous at any point (p,m) where m > 0. Solution: The closed graph property follows immediately from the previous example (with A = fx: x > 0). ‘To prove that the correspondence is lower hemicontinuous when m > 0, itis enough to show that B(p, m) = Bp, m), where B°(p, m) = (x > 0: p-x < m). Given any x € Bip,m), let ae = (1 ~ 1/K), k= 1, 2,.... Then gx -+ x as k + 00. Moreover, as p-x 0, one has p-agx < aym < m, so apx belongs to B°(p. m), which proves the asserted equality. ’ ‘Here is an alternative condition for lower hemicontinuty “ALTERNATIVE CHARACTERIZATION OF LOWER HEMICONTINUITY ~—— ‘A correspondence F : X CR" + R™ is lower hemicontinuous a x° in X if and only if for each y" in F(x) and each neighbourhood U of y°, there exiss a neighbourhood o of x" such that F(x) 0 # 0 for all xin NX. Proof: Suppose that F : X — 8 satisfies (7) ata point? in X, that y® € FW) and thats, — x? 48 k ~ co, Let (7) be any sequence of postive numbers such that fy —> O.as > 00. Given a ‘neighbourhood B(y";r,) oy”, contin (7 implies that there exists a neighbourhood N of x such that F(3)9 BUG: r) 2 whenever x € N'OVX. But chere exists a k* such that > E* implies Xi € NX, so there exists ay in Fea) such that yx € BUS 74). Clearly ye > 9°, 0 F satisfies Sax’ Onithe other hand, suppose F does not satisy (7) ate point x° in X. Then there exist a point 4? © F(Q°) anda neighbourhood U of y" such tat every neighbourhood N of x includes a east ‘one point xy satisfying F (xy) NU = 0, Hence, there exists a sequence (x, in X sch that xy = x! ask = coand F(a) AU = 9 forall k= 1. Butthen no sequence (y) withy; © Fla). k= 1,2, can possibly converge to y*, So F cannot satisty (5) at . ‘Comparing (7) with the corresponding topological condition for continuous functions leads immediately to the following important result: (CONTINUOUS FUNCTIONS ARE L-H.C. CORRESPONDENCES) THEOREM 14.41 A function x ++ f(x) is continuous at a point x° of its domain X if and only if the associated correspondence x + (£(x)] is lower hemicontinuous at x°. Proof: Given any neighbourhood U of {£(%°)}, one has (f()] NU £ <=> f(x) €U So {£(8)] OU # @ for all x € NX iff EV .X) ¢ U, or iff NX Cf"). The result follows from (7) because the topological condition for f to be continuous at x? is that NX € f-\(W) for some neighbourhood 1V of x? whenever U is a neighbourhood of (f03°)) .500 CHAPTER 14 7 CORRESPONDENCES AND FIXED POINTS Upper Hemicontinuity ‘Now that lower hemicontinuity has been defined for correspondences, it is natural to ask ‘whether there isa similar concept of upper hemicontinuity. Re ee A correspondence F : X © BR — 02" is said to be upper hemicontinuous (or hie.) at a point x° in X if for every open set U that contains F(x°) there exists neighbourhood N of x? such that F(x) CU forevery xin NX—ie.such (8) that F(X) ¢ U. F is upper hemicontinuous (or w.h.c.) in X if itis wh. at every x in X. As was the case with hc. comespondences, the following result is an immediate implication of definition (8): ‘The function x +> f(x) is continuous at a point x° of its domain X if and only if the associated correspondence x -» (f(x) is upper hemicontinuous atx” Proof: Let U be open set containing f(x°) and let N’ be a neighbourhood of x°. Note that f(NAX) CU <> NOX Cf“). The theorem follows from this equivalence. NOTE 1 If F : X — Bis upper hemicontinuous at & point x” in X and F(x) isa closed set, then F(x) has the closed graph property at x°. (Proof: Let xx — x°, yx > y®, and ‘Ye € F(x). Assume y° ¢ F(x°). There is a closed ball B around y° which is small enough not to intersect the closed set F(x"). Applying (8) tothe open set CB = RB” \ B, there exists a neighbourhood N of x° such that F(N 1X) € CB. But for k large one has Xe € NOX cand 80 yg € F(x) © CB. It follows that yg does not converge to y°.) ‘On the other hand, the following theorem also holds. ‘Suppose that the correspondence F : X C R" + R™ has aclosed graph atx” and that is locally bounded near x° inthe sense that thete exists a neighbourhood N of x? such that F(N OX) = Usennx P08) is a bounded set, Then F is upper hemicontinuous at x°.THEOREM 14:14 (COMPACT GRAPH SECTION 14.1 / CORRESPONDENCES 501 Proof: Let N be es in the theorem, and let B(x°; @) CN. Suppose that F is not wh. at x° in X. Then there must exist an open set U 2 F(x") such that, given any ball B(x°: a/), = 1,2,...ythere exits any in B(x, /&) 1X for which F(X) £ U. Choose vectors ¥, in F(x.) U. The boundedness property in the theorem implies that fy] has a subsequence {,) that converges to some point yin F(x°) as r — oo. Because R"\ U is closed and Ye, ERE \U, itty aoo Yt, = ¥" € RY \U, the limit y° ¢ F(X), a contradiction . ‘The following result isan immediate consequence. Ifa correspondence F from XC f" to ¥ C BM has a compact graph, then itis upper hemicontinuous. Problem 1 concerns an example of a (non-compact-valued) correspondence which has the closed graph property, but which is not upper hemicontinuous. Theorems 14.1.1 and 14.1.2 show that, if a correspondence is single-valued and so collapses to a function, then either "upper or lower hemicontinuity (separately) implies that the function is continuous, ‘A correspondence that is both upper and lower hemicontinuous is called continuous. Of course, any constant-valued correspondence is continuous, as is any single-valued corres- pondence that collapses to a continuous function. But so are many others. Composite Correspondences Wf: A> Bandg : B— Carefmstions,thenthecompostion h = ffisthe funtion = A> C sven by ta) = g(/C0), Silay, fF vA and GB > Care eorespondener, hen the Composite correspondence Hf = Gs FA Cis defined by H@)=G(Fa) = U Go) ‘Thus, H(x) isthe union of all the sets Gp) that are obained as y rans though Fs). This means that z € HG) ifand only iz GC) frat east one yin F(x) Recall thatthe composion of two continuous functions is continuous. For corespondences between sets in Euclidean spaces we have the following results: is) Let Fi X CRY Y CRY and G: Y —~ Z © RP be comespondences, and let H = GoF:X + Z be their composition, Then: (@) If F and G have closed graphs and ¥ is compact, then HT has the closed graph propery. (b) If F is upper hemicontinuous at x° in X and G is uppet hemicontinuows at every point of F(x), then H is upper hemicontinuous at x°, (©) I F is lower hemicontinuous atx” in X and G is lower hemicontinuows at every Point of F(x°), then £7 is lower hemicontinuous at x"502 PROBLEMS FOR SECTION 14.1000 > CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS Proof: (a) Suppose that (x,) and (z¢} are convergent sequences in X and Z respectively, sucl that 4 € H(x) forall k, x° = lim, x; © X, and 2° = limg x. We must show that 2? € H(x"). The definition ofa composite correspondence implies that foreach k there exists ay in F(x.) soo hat, 4% © G(y,). Because ¥ is compact, {ys} has a convergent subsequence {y1,. Let y? = lime ys. ‘The corresponding subsequences (x, and (x, | of 4] and (ze) converge ox and 2 respectively. Because y,, ¢ F(xu,) for al r, the closed graph properties of F and G imply that y® © F(x!) and 2 © Gy”). It follows that 2° = Hix"), (b) Let U be any open set containing H(3). Since HW") = User G() the set U contains G(y) for every y € F(x"). Because G is u.h.c., for each such y there exists an open neighbourhood ‘Ny ofy such hat GQ?) € U whenever y © NyO¥. Define N* = Upenia Ny-Asthe union of pen sets, this is an open set containing F(x°). Because F is u.h.c. at x°, there must exist a neighbourhood N of x such that F(x) CN" OY whenever x € WN’ X. Bu then, forall such x, one has #@= Yoms U cod= U [ U oo |e 20) veteoy serabLyeiinr ‘This confirms that His wh. atx, () This (much easier) proof is left othe reader—see Problem 11 . Re 1. Let F(x) = [1/x) for x # 0, with F() = (0), Prove that f has the closed graph property, but is not upper hemicontinuous. 2. Determine by a geometric argument whether or not the correspondences given by the following graphs have closed graphs andlor are lower hemicontinuous. @ ©) © 3. Let the correspondence F : Ry = [0,00) —* Ry. be given by F(x) = [0, 1/x] for x > Oand F(0) = Ry. Prove that F has a closed graph and is lower hemicontinuous, 4, IF: X + Bland G : X — RM are correspondences defined on a set X ¢ Re", the product correspondence H = F x G: X > '™ is defined by H(x) = F(x) x GO), for all x in X, Prove that if F and G are lower hemicontinuous at x°, then His also ower hemicontinuous at x°, Similarly, prove that if F and G are compact-valued and if they are upper hemicontinuous at x°, then H is also upper hemicontinuous at x”, '5. Suppose that the two compact-valued correspondences F,G : X Cf" — RM are upper hemicontinuous at a point x° in X. Consider the summation correspondenceSECTION 14.1 7 CORRESPONDENCES S03 HX ~» BR defined by H(x) = F(x) + G(x) for all x in X. Prove that H is upper hemicontinuous at x°. What may go wrong if F and G are not compact-valued? 6. Suppose F : X C'R" —» R” is lower hemicontinuous at a point x° in X. Let G : X —» R® be the correspondence whose value at each x in X is the convex hull co(F(x)). Prove that G is Lhe. atx" 7, Prove the following result: (Sequence test for upper hemicontinuity.) A compact- valued correspondence F : X © R" -» RM is upper hemicontinuous at x° in X if, whenever {(Xz, ys)} isa sequence of points in graph(F) for which x —+ x? ask + 00, the corresponding sequence (y,} has a convergent subsequence whose limit is « point of F(x"), (The converse is also true.) HARDER PROBLEMS 8. Let the functions g;(x, y) in Example 5 be continuous in (x, y) and convex in y. Fur- thermore, suppose that {y : gi(X, y) < by for # = 1, ..,} is nonempty forall x. Show that the correspondence # defined in Example 5 is then lower hemicontinuous. (Hint: Use the result in Example 5 and, for any y’ in P(x), take y in sP°(x) and show that "= dy + (1 ~A)y' © P(x) ford in (0, 1), then let 2 + 0.) 9. Let the functions gi(x,y) in Example 5 be continuous, and have continuous par- tial derivatives wat yt, ...5 )ye- Furthermore, suppose that for all pairs (x, ¥) with (8, y) Eb, the rank of the matrix with entries g(x, y)/@x;, where j = 1, ...,m and i © S(&,y) = {i : g(x,y) = 6,) is equal to the number of elements in the set S(x,y). Prove that the correspondence P(x) is then lower hemicontinuous. (Hint: Use Example 5.) 10. Let a(x) and b(x) be two continuous functions mapping B into R, with a(x) < B(x) for all x. Of all the different possible correspondences F : R — R that satisty (a(x), B®) © FO) S fax), bY] forall x, which are lowerhemicontinuous, and which are upper hemicontinuous? (Hint: First examine the case when a(x) and B(x) are both constants.) 11. Prove part (c) of Theorem 14.1.5. 12. Let F : X CR" — BR” be a compact-valued correspondence and let G : X — R™ be the correspondence whose value at each x in X is the convex hull eo(F(x)). Prove that if F is upper hemicontinnous at x°, then G is also upper hemicontinuous at x°. (Hint: Apply Carathéodory’s theorem.)504 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS 14.2 A Generai Ma: mum Theorem Assume that F(x) is a correspondence from X © R" into Y ¢ @", and let f(x, y) be a function from X x ¥ into ®, Consider the maximization problem maximize f(x,y) subjectto y € FO) @ Define the choice or behaviour correspondence ¥* from X into ¥ by Y*(x) = argmax f(x,y) = {¥ © FO): fO,2) 5 f(x,y) forallzin F@)} @) YF) ‘Thus for each x in X, the set ¥*(x) consists of all the values ofthe argument y that maximize “fx, y) as y nuns through the set F(x).! Symbolically, we can illustrate the problem as in Fig. 1 Figure 1 ‘Also define the corresponding value function: Vix) = sup FY) @ seF on) ‘The function Vis well defined on the effective domain of F., If for some x the supremum is attained at some §, then V(x) = f(X,§) = maxyeria f(x,y). Note that if x © X and y © ¥°(x), then Vix) = f(x,y). Infact, ¥*(x) = [y € F(R): fy) = VO] Here is a general (but somewhat vague) economic interpretation. First, x is @ vector of exogenous parameters that jointly describe the “environment” faced by some maximizing economic agent. Given this vector x, the feasible set F(x) describes what options are available. Let /(x, y) measure the benefit to the economic agent from choosing the point y in F(x) in situation x. Then Y*(x) is the set of choices of y that maximize benefit In general, we are interested in finding the strongest possible continuity properties of Y*(x) and V(x). Here is the main result, Tn general, Fora funtion g = SR the notation arg mats (s) is used to denote the set of all values ofthe argument sin $ that maximize @).SECTION 14.2 / A GENERAL MAXIMUM THEOREM THEOREM 141209 (GHE MAXIMUM THEOREM), ‘Suppose that x -» F (x) isa cosrespondence from X ¢ "into Y CR” that has nonempty compact values for all x in X and is continuous (ie. both upper and lower hemicontinuous) at x" in X. Let f(x, y) be a continuous function from X x ¥ imo, Define ¥°(%) = [y © Fox): fx, 2) < f(x, y) for all zin F(x) } ‘Then ¥*(x) is nonempty for all x in X. Moreover, the choice correspondence x ¥*(x) is uh.c. atx”, and the value function V(x) is continuous at x°, 505 Proof: Because F has nonempty:compact values for all x in X, the extreme-value theorem implies that ¥*(x) # @ for all x in X. ‘Let W be an open bounded set containing F(x"). Because F is assumed to be upper hhemicontinuous, there isa ball U around x® such that F(x) © W whenever € U. Applying ‘Theorem 14.1.4 (with X = UV), upper hemicontinuity of Y*(x) at x" will follow provided. ‘we an show that ¥* has the closed graph property atx°. Let [xe] be any sequence of points in U that converges to x" as k — 00 and let ys € ¥'*(xx) converge to y°. We want to prove that y® ¥*(x°), and also that V(x) > V(x®), (D) Because F has the closed graph property at x? and ys € ¥*(x,) © F(a) for each k, we have y" ¢ F(x"), (2) Take an arbitrary 2” in F(x"). Because F is lower hemicontinuous at x° and x, = x°, there exists a sequence (24) with 2 € F(x) and z; — 2°. Now yx € ¥*(xi) and 2% € F(X), so the definition of ¥* implies that f(x, 2) <= (xe, yx). Taking the limit ask > 00, continuity of f implies that f(x°,2°) = f(x°,y®), Because the choice of 2° in F(x) was arbitrary, it follows that y° ¢ ¥*(x°). (3) The sequence {V(xs)]k of real numbers, even if itis unbounded, has a subsequence (¥(%,)}- which converges to a limit v, which may be infinite. Let yz € ¥"(x) for each k. Because x, > x° and we have shown that Y*(x) is wh.c. at x°, the sub- sequence ((xi,,yi,)l- has @ convergent “subsubsequence” {(X',,¥)}m Whose limit must be a pair (x°.y¥’) with y’ ¢ ¥*(x°) and so f(x,y’) = Vin®), Obviously, Yor € Y*(X,) for each m, and so ViX,,) = f(¥%,¥q). But f is continous, so F(Xiq Yn) > £00", y') = V(X°). Because f(x},, ¥iq) + V as m —+ 00, this proves. that any subsequence of (V (x.)}x that converges, even (o infinity, must have the limit v= V(x"), Hence Vix) > VX), NOTE 1 Suppose there is a real-valued continuous function a(x) such that the corres: pondence xr» F(x) = (y € ¥ : F(X) (f(y) = ax)} is nonempty and com- pact for all x in X, as well as upper hemicontinuous at x°. Then in Theorem 14.2.1, upper hemicontinuity of F(x) at x° and compactness of F(x) can be dropped because OY Fis) by F*() fy © F*(x) : f(x.2) < f(x,y) for all z in F*(x)}, 0 one can replace506 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS EXAMPLE T EXAMPLE 2 ‘EXAMPLE 3 In connection with Example 13.4.1 define the correspondence # for all x by F(x) = [-1,2]. Then all the assumptions in Theorem 14.2.1 are satisfied and the set ¥*(x) is ¥e(x) = ty € (1,2) x2? < xy? forall z € [=1, 2). It follows that (0) whenx <0 Yr(x) = 4 [-1,2] whens =0 2) whens > 0 (For instance, if x < 0, then ¥*(x) consists of all y € [1,2] such that y? for all z € [-1,2]. In particular, y> < 0, so y = 0.) The correspondence x H+» ¥*(x) is upper hemicontinuous. (Draw a figure!) ' Let K be a nonempty compact convex set in 2", For all x in R®, define 8(x, K) = mind(x, y), yx) = argmin d(x, y) wee yek where d(x, y) is the Euclidean distance. Thus 5(x, K) can be interpreted as the minimum distance from x to K. Since (d(x, y))? is a strictly convex function of y, it has a unique ‘minimum over the convex set K of possible values of y. Hence, ¥/(x) is single-valued— ive, W(x) = (y*C3)) for some function y*(x). In addition, the correspondence x +> K is cconstant-valued, so continous. Hence, the maximum theorem applies. The correspondence x H+ W(X) is therefore whc., implying that the function x +> y*(x) is continuous. In addition, x +> 5(x, K) = d(x, ¥*()) is also continuous. ' (Profit Maximization) Suppose a frm produces a single output commodity using 1 cifferent factors of production as inputs. Let the vector of strictly positive unit prices for the inputs be w = (u;.---tty) > 0. Suppose thatthe firm's minimum cost, when faced with input prices w > 0 ‘nd prodocing ouput y >, is given by the function C(w. y). One expects C to be increasing in win the sense that C(w’, y) 2 C(o,y) whenever w’ 2 w, and that Cw, 0) = 0. This will be assumed, as well as tht CW, y) is continuous function. One also expects C to be increasing in ‘y and homogeneous of degree one in w. in the sense that C(aw, y) = AC(w, 9) fr alli > 0. All ‘ese properties are assumed here; that they are reasonable follows from the next example. Finally in order to ensure that profits remain bounded, assume that for each fied w >> 0 the average cost C(w. y)/y tends to 0° a8 y — 0. ‘Lat p > Odenote the price per unit of output. Consider the problem of maximizing the firm's profit py — Cw, 9) by an appropriate choice of output y, We are interested in showing thatthe Supply correspondence (p. w) r n(p. W) = argmax, py ~ Cw, y)} is wh. and that the profit function (Doo) > (p.%8) = WwaXy{py — CCW. )} is continuovs. Te seems that the maximum theorem shouldbe helpful, but here is dificult because the elevant feasible set (yy = 0) isnot compact. However, define the set P(w, p) = (y = 0: py = Cw. 9) > 0}, Ibis nonempty because (0 € Fim). Choose any w° >> Qand p? > 0. Because average cost C(w!/2, y)/y > 00 a8 'y-—> 00, by hypothesis, a number y* can be so chosen that C(w!/2, ») > 2p®y forall y > y*. We ‘aim that Fw, p) & 10, y*] for w >> w"/2, p < 2p. To se this, note that y > y* gives negative profits because py — Cw. y) < 2p%y — Clm"/2, y) < 0. Arguing asin Example 14.1.5, Fw, P) has the closed graph property for w > w° and p < p®. Because (0. y] is bounded, Theorem 14.1.3 implies that F'(w, p) is upper hemicontinuous for all such w, p. Finally, applying Note 1 with F(w, p) = [0, 00) shows that (wp) i continuous and n¢w, p) is upper hemicontinvous for w > wi)? and p < 2p®. The same result extends to all w >> 0, p? > 0, since w? and p° were arbitrary. ’SECTION 14.2 / A GENERAL MAXIMUM THEOREM 507 EXAMPLE 4 | (CostMinimization) Consider the same mas inthe previous example. Suppose that the level of ouputis determined by the production function x), where X= Cr...) is the input vector Suppose aso that fis defined and continuous on ihe set RE = (x € RY FO) whenever x’ 2 x, with f(x’) > f(x) whenever x 3> x Consider te set ¥ = #2.) € R@ of al possible ouput levels thatthe firm can produce. It must be an interval of the form (0,3), where $ may be +00. (There can be no x such that f(8) = 3 because f(s) > f(®) whenever x > X. Given any input price vector w >> 0 the fmm’ tal) cost is given by w x. We shall now study the frmn's cost faction, which specifies the minimum cost of producing a given ouput level y in ¥ when the input price vector is w. Its ven by Coo, ») = min{w-x: 0) = y} In particular, we would like to apply Theorem 14.2.1 in order to demonstrate that C(w, ») is @ ‘continuous function, and the input demand correspondence, defined by E(w, y) = argming wx: f08) > y) is be upper hemicontimuous. A dificult hee is thatthe consuait set X(w,») = (x @ RE + FW) > y} is definitly tunbounded, So, eventhough itis closed, itis not compact. So let us turn to Note 1. Given any # >> 0 and any j in ¥ = [0 5), its enough to prove continuity of C and upper hemicontinity of € in & neighbourhood of (W, 5) such as W x F, where W = {w: 8/2 < w < 2A) and F = [0, 3) for ‘some point in 3, 3). Let be the vector whose components ae all 1. Monotonicity guarantees that /(B1) isa stritly increasing function of f > O, with f(OL) = Oand f(B1) > f(x) when f(x and f isso large that 1 2 x. Hence, there exists a such that f(1) = 5. Given tis 8, define Fou = 20: faye y, wx S28-G) Consider any fined in W >. Nowe that Fw, y). Also any xin Fw, 3) must saisty JW ex < wx < 2W- (AD), and so Fw, y) CA, where A= (x © RE: Wx =< 28-(BN)}, which 's obviously a bounded set. Arguing as in Example 14.1.5, F has a closed graph at every point of Wx ¥, so Theorem 14.1.3 implies that Fis whe. throughout W x Y. Because f is monotonic, its ensy to see that F(w, y) is the closure ofthe set {x >> 0: f(x) > y, W-x < 29 (B1)]. Then the result of Example 14.1.5 shows that F is also Lh. throughout W x ¥. So Note { applies and gives, continuity of C(w, y) and upper hemicontinity of F(w, y) in W x ¥. Since W and 9 were arbitrary, ‘these properties hold for all w > 0, y = 0. i PROBLEMS FOR SECTION 14.2 si ‘i é 1. Let f(x, y) = —y4+x(y?=1) forall x and—1 < y < 1,andconsider the maximization problem max_1> 0 and m > O. ‘What can go wrong if p; = O for some i? 3. Suppose thatthe utility function of the consumer in Problem 2 is continuous but not «ven quasi-concave. What continuity properties can then be expected of the consumer's demand correspondence (p,m) +» £(p, m) and indirect utility function V (p,m)? What Jifference would quasi-concavity make fo the demand correspondence? Fixed Points for Contraction Mappings ‘This brief section presents a so-called fixed point theorem with important applications to economics. In particular itis used in Section 12.3 in connection with the Bellman equation in infinite horizon dynamic programming. ‘A function F from a set S into R" is called bounded on S if there exists a positive number M such that F()|| = M forall xin S. Let S be a subset of IR", and let 8 denote the set ofall bounded functions from $ into RY. We define the distance between two functions g and y in # as (@,¥) = sup ls) — #91 LetT : 8 — be a function (or “operator”) that maps each function g in & to a function T(g) in B. Thus T(g) is also a bounded function S > R™, We will write 7(9)(x) for the value of 7(g) at a point x in $. The function T called a contraction mapping if there exists a constant f in (0, 1) such that for all @ and in 8, one has ITN) - THO < Bale, W) forall xin § a ot, equivalently, ar(), TH) = Bde. ¥) co) For any two elements g and W of , the distance between T() and T(W) is then at most B times the distance between g and W, hence the name contraction mapping. Let 5 be a nonempty subset of f" and let B be the set of all bounded functions from $ into R™, Suppose that the operator T : 8 > B isa contraction mapping. ‘Then there exists @ unique function 9" in 8 such that @° = T(g").SECTION 14,3 / FIXED POINTS FOR CONTRACTION MAPPINGS S09 Proof: Since Tis a contraction, there exists a 8 in (0, 1) such that (2) is satisfied for all 4g and yin B. Choose an arbitrary function go in B. Define @, = T(@0), and generally Gast =T (Gn) for n = 0, 1,2,.... Let Ye = (Past, Yx)- Then (2) implies that Yost = A(us2, Past) = AT es). Ta) 5 BA Gast. Pr) = BY 20 @ An obvious induction argument shows that yj, < By. We want to prove that for each point x in S, the sequence (g(x) is 2 Cauchy sequence in R”. To this end note that Prk Gn = Gere — Pritt) + (usk-t — Onsh-2) + Onvt — Ga) ‘Therefore, for every x in S, whenever m > n it follows from the triangle inequality that os wl Hen) — e4(9)1 = | 2.2108) - @0)] = Yo Norn) — e001 ai) ‘The last expression is small when n is large. Hence gq(x) is indeed a Cauchy sequence, with a limit g*(x). Letting m — oo in the inequalities (i), with n fixed, we see that 19") ~ @n(9)l| < B"yo/(1 — B) for all xin S, Now, NTC" ~ Gas1GIl = IT") ~ T@AO)Il < A ya/1 — B) by (1), Letting n + oo yields g(x) = T(y")(x) for all x, and so T(g") = 9”. If another function ™ satisties T(g™) = g", then by (2), ag" 4(T(@"), TW) = Bal", @"*) Because < 6 < landd(g*, @**) > 0, tfollows thatd(g*, O.hence gp" = 9". NOTE 1 Theconclusion ofthe theorem remains tue f is restricted oonly those bounded functions g : S—> R" that satisfy the inequality p(X) — yol < A fora given point yo in RM and. given number A, ic. every ¢@ in maps $ into the closed ball of radius A around the point yo. I also remains true if we require that ig(x) — @(x’)|| <= Mllx — x’ for all x and xin S and a common given number M. It even remains tue if both conditions ate imposed on the elements of B. To see this, note that if the relevant inequality or inequalities hold for each gin the proof above, they still old after passing tothe limit (as n > 00) EXAMPLES Asan example of how one can us the contraction mapping theorem, we prove Theorem ‘58.2 on the existence and uniqueness of solutions of differential equations.510 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS 14.4 Proof: We use the aotation in Theoreas 5.8.2. Further, et K = many ayer |E{(E, 49) and k= mina, B/M, 1/@K)}. By the mean-value theorem, |F(¢,x) = F(t,x)| = Klx =. for all ¢ in {to = a, fa] and all x, xin (xp — b,x +6). ‘We first prove the existence ofa unique solution over the interval (ty ~rsto +1). A function x" solves te initial value problem & = F(t, x), x} ty — bs + K] instead of cy iF and only if F@=n+ [ Fe.xepds for all in. Suppose s* isa solution, Then for and in I we have wineaoye|f Reel eam! since |F(5.2)| < M forall (5,1) in P. Let be the set of al functions: T—» Redhat sat Fg) = 20 and fx’) — x01 © MW —t| forall in T. The set 2 is nonempty, since t Contain he contat fection = xe, ad all neon that belong to # sre continuous. Then the opertor T's — 8 defined by TOK") = ay + fy F219) i wel defined. (You Should verity tht (0) Hes n For any two faneons's and tn and any +i Fe Bae 1FG.548))~ FG. 2))| ¢ KIRG) ~ 5001 = RAG 8) and 30 ITU) = TEI) = if (F(5,3(6)) — F(s, x(6))) ds| = lp ~ tol KE, x) = $d, 2) since t—fg| <¢F-< 1/(2K).Ifllows that (TCH), Ta) = supp IP@O~PO| 5 $A». Hence T isa contraction and by Theorem 14.3.1 and the sveceoting note, ith a unique fixed point So far we have proved the existence ofa unique solution ove to ~ ft + I. To extend tis solution tal of ~ to + 7, note tat we ean use the same construction to show that thet isa ‘nique solution ina neighbourhood of any pont in. One can then spice together two sotons that agree on some common subintrval oftheir domains, nd obtain soluon over the union ofthe doin. In this way. one ean obtain a solution over all af (jy ~ 1. to +7). We refrain from going into the details ere. . Brouwer’s and Kakutani’s Fixed Point Theorems Consider a function f that maps each point x of a set K in R" to a point f(x) of the same set K. We say that f maps the set K into itself. Usually, x and f(x) will be different. Ifx* is a point such that f(x") = x", that is, if the point x* is mapped to itself, then x" is called a fixed point of f. ‘We would like to find conditions ensuring that any continuous function mapping K into itself has a fixed point. Note that some restrictions must be placed on K. For instance, the ‘continuous mapping f(x) = x + 1 of the real ine into itself has no fixed point; this is because f(2*) = x* would imply that x* +1 = .2*, which is absurd. ‘The following result by L.EJ. Brouwer yields sufficient conditions forthe existence of «fixed point. (See Iehishi (1983) for a proof)SECTION 14.4 / BROUWER'S AND KAKUTANI’S FIXED POINT THEOREMS 511 THEOREM 14.4.1. (BROUWER'S FIXED POINT THEOREM) Let K be a nonempty compact (closed and bounded) convex set in R”, and fa continous function mapping K into itself, Then f has a fixed point x*, ie, a point x* in K such that fx*) =x" ‘The function fin the theorem maps points xin 2" into points yin ®". Itis therefore described. by the system Sars So a fixed point x* = (xf, ..., rf) of f must satisfy the equation system Fi Bey Y2= AC We ves Th Jn) B= Aili eo) w 2) This immediately shows how Brouwer's fixed point theorem can be used to establish the existence ofa solution fo & nonlinear system of equations. Note, however, that inorder to apply the theorem one must establish the continuity of f and prove that f maps a suitable domain K into itself. ‘There are numerous applications of Brouwer's theorem in which the set K is the standard ‘unit simplex "~' in R” defined by * eC 0.0.1) (1.0.0) Figure 1 f maps A? into itself, Figure 2._f(" For instance, x1, ..., 4» might denote the nonnegative prices of n different commodities, these prices being normalized by the convention that x1 +--+ +%q = 1 "Note that 4°" is (v— D-dimensional, For example, A? is contained in the (2-dimeasional) plane 2142-422 =1 in, See Fig 1512 CHAPTER 14 7 CORRESPONDENCES AND FIXED POINTS The set A"! is convex and compact. To see whether Browwer’s theorem applies t0 a given continuous function f defined on A", it is only necessary to check that f maps A" into itself. If is given by (1), then f will map 4"! into itself provided that for all (tees %9) im A, one has ACen) 20, cee fatter kn) 200 DAG al BD is illustrated in Fig. 1. Brouwer's theorem implies that if f maps A? ‘The case when n continuously into A?, then there must be at least one point x* in A? for which f(x") In R! (the real line), a nonempty compact convex set must be a closed and bounded interval (a, b](orasingle point). So Brouwer’s theorem asserts that a continuous function f [a, 5] > [a, b] must have a fixed point. But in this case, this follows from the intermediate value theorem. (Indeed, g(x) = /(x) —x satisies g(a) = 0, and g(b) < 0, so for some x* in [a, 6), g(x") = 0.) The geometric content of this proposition is illustrated in Fig. 2, The ‘graph of f must cross the diagonal y An Illustration For the two-dimensional case the following illustration ofthe theorem might aid your intuition. Do not take the illustration too seriously, however! Imagine an enormous flock of sheep crammed into a circular pen. Suppose that the flock suddenly starts moving and then stops after a certain time. Ata given moment of time each sheep has a definite positon inthe pen, as shown in Fig. 3. Although each sheep can move, no sheep can move against ‘across the stream, so each sheep must stay’ close to its original neighbours. Consider the mapping from the position originally occupied by each sheep to its final position after stopping, By the assumptions above, this isa continuous mapping (a dubious claim) of the pen {nt itself. Because the penis a compact convex set, Brouwer's theorem applies. So there must beat least one “fixed sheep” which stops exactly where it started, Figure 3 [Now assume instead thatthe flock is enclosed in a circular ring, as indicated in Fig. 4. Suppose all sheep move 90 degrees clockwise around the ring. Then each sheep will stop in an entirely new position. No"“fixed sheep” exists in this case, As above, the movement indicated defines a continuous ‘mapping of the pen int itself, bur there is no fixed point. In fact, Brouwer's theorem does not apply since the ring of Fig. 4 is not a convex st. ‘The importance of ths result for sheep farmers can hardly be underestimated, bu it does indicate an important “topological difference” between a citcular disc and a rng.SECTION 14,4 7 BROUWER'S AND KAKUTANI'S FIXED POINT THEOREMS 513, A Generalization ‘The convexity hypothesis in Theorem 144.1 can be relaxed. Let L ¢ &" be « homeomorphic image of K in'the seas that there exists a one-to-one continuous mapping g of K onto L (ue. g(K) = L) ‘whose inverse mapping g~" is also continuous, Intuitively, homeomorphic images of a rubber ball are obtained by squashing or stretching, as long as we do not tear it apart, make aay holes, or glue parts together. Note, in particular, that homeomorphic images of a convex set are not necessarily ‘convex. The natural generalization of Brouwer’s theorem is: Any homeomorphic image L of « nonempty compact convex set K © R has the sed 4) point propery, ie. any continuous function f mapping L into L has 2 fixed point. Proof: Let be the continuous function mapping L into L, and let g be a homeomorphism—i.. ‘ continuous mapping of K onto L with a continuous inverse g~. If x € K, then gtx) € L, 80 (g(x) € L, which implies that g~!(f(g’x))) € K. So the mapping g~'fg must be « continuous function of K into itself. According to Theorem 14.4.1, there exists a fixed point x” in K’ such that °(f(g(x"))) = x". But then gia") = f(gix"). and so g(x") in L is a fixed point for f. . Brouwer’s original motivation for his theorem was to examine the topological differences between various sets in R®. It was recognized only later that the theorem had interesting applications outside topology. The next section shows how Brouwer's theorem can be used to prove the existence of an equilibrium in a pure exchange economy. Although this type of economy is very simple and unrealistic, the existence proof contains many of the essential features that arise in richer general equilibrium models, Kakutani’s Fixed Point Theorem Brouwer’s theorem deals with fixed points of continuous functions on appropriate domains. Kakutani’s theorem generalizes the theorem to correspondences. It is a reformulation of an existence theorem for saddle points proved by von Neumann in 1928 and used in his work ‘on both game theory and growth theory. (For a proof, see Aubin and Frankowska (1990).) “THEOREM 14.4.2 ((KAKUTANI'S FIXED POINT THEOREM) ———~ Let K bea nonempty compact convex set in R" and Fa correspondence K— K. Suppose that: (a) F(x) is a nonempty convex set in K for each x in K (b) F is upper hemicontinous. ‘Then F has a fixed point x* in K. ic. a point x° such that x* € F(x"). Notice that Brouwer's theorem is implied by Kakutani’s because a continuous function £ ‘mapping the compact domain K & into itself has an associated correspondence with non-empty convex values defined by F(x) = {f(3)} for all x in K. This correspondence is "upper hemicontinuous by Theorem 14.1.2, and so has the closed graph property.514 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS In the one-dimensional ease, Theorem 14.1.2 takes the Form: Ifthe correspondence F : [a,b] ~ {a, 5] has the closed graph property, where F(x) is a nonempiy closed interval for each x in a, 8}, then F has a fixed point. © Proof: For each x in (a, 6], the image of F isa closed interval depending on x, say F(x) [FG), g(@)], Define x* = sup € (a,b): f(x) 2 x). We claim that f(a") = x° = g(2"), which seams that x* € F(2*) and thus x i a fixed pont. ‘To prove that f(x") < x*, note that this is rivil if. x* = , 90 assume x* < >. Suppose contrary 1 the assumption that f(x") > x*. Then also f(x") > x* +6 for some © > 0. Fis Upper hemicontinuous at x* (Theorem 14.1.3). According to definition (14.1.8), t0 the open set U = ("+ 6,00) containing F(x") = [/(s*), @(2")] there exists a neighbourhood N’ of 2° such that for zin N 7a, 6), we have F(z) = [f(2), g(2)] € U. Then, in particular, forz in N Aa {fl2) > x*+e. If wechoose N so smallthatallzin N satisfy 2* <2 < x*4e,then f(z) > xt+e >, contradicting the definition of s* To prove tat g(x") = x*, note tha this is rival if.x* = a, so assume x* > a. Suppose contrary tothe assumption that ¢(:*) < x*. Then also g(x*) < 1*~« forsome e > 0. Upperhemicontinuity of F atx* implies that F(z) © (=00.x" ~ 6) S (~c0,2) for all z close enough to. with < 3° and > x*~e, Butthen f(s) < g(@) E and Tp: B > B. Does either transformation have a fixed point? Explain the results in the light of Brouwer's theorem, 3. Let A = (ay) be ann x n matrix whose elements all satisfy aj; 2 0. Assume that all column sums are 1, so that 0", aij = 1 (j = 1,....7). Prove that ffx ¢ A"', then Ax € A°-1, where A*~? is the unit simplex defined by (2). Hence, x1 Ax is a (linear) transformation of A" into itself. What does Brouwer's theorem say in this 4, Consider the correspondence F : {0,2} + [0, 2} that maps each x in (0, 1) to (2), maps x = 1 10 (0, 2}, and finally maps each x in (1, 2}10 {0}. Draw the graph of F and determine whether F has a closed graph, Does Kakutani’s theorem apply? HARDER PROBLEMS 5. Assume that f : [0,1] + {0,1} satisfies Ti .- f(8) < £2) < Tiiyoer f(s) forall x in (0, 1}. nly the right-hand (lfi-hand) inequality is required to hold for x = 0 (x = 1),) Prove that f has a fixed point. (Hint: Consider x* = sup A, where A= (re [01]: f@) =x) Equilibrium in a Pure Exchange Economy Consider an economy with m consumers, each of whom is intially endowed with fixed quantities of n different commodities or goods. No production is possible, so the consumers merely engage in exchange. Trade takes place because each consumer wishes to acquire a bundle of commodities that is preferred to the initial endowment. This is described as @ pure exchange economy. ‘As usual when discussing perfectly competitive markets, we assume thst consumers can exchange their commodities at fixed price ratios, Specifically, we assume that a price vector P= (pi,--+. Pn) is announced, where p; is the nonnegative price per unit of commodity ‘number i. Thus, any consumer can sell one unit of commodity j for the amount pj, and use that amount to buy any other commodity i at the price py. In this way, the one unit of commodity j has the same value as p;/p; units of commodity i (assuming that p; > 0) ‘The price vector p determines the market value p € = S7f., pici of any commodity bundle ¢ = (ci,...,¢,), including any consumer’s intial endowment. By exchanging at the fixed price ratios p/p, the consumer can achieve any commodity bundle whose market value equals that of the initial endowment, These are the affordable consumption bundles at which the consumer satisfies his or her budget constraint. Among all affordable commodity bundles, each consumer selects one that is weakly proferred to all the others. In other words, each consumer’s demands represent the choice of516 CHAPTER 14 / CORRESPONDENCES AND FIXED POINTS commodity bundle that maximizes a uty funetion subject to that consumer's own budget constraint. (We assume that there isa unique utility maximizing consumption bundle.) ‘Next, add the demands ofall consumers for each commodity / and subtract the total inital endowment of i. The results called the excess demand for that commodity. Because it depends on the price vector p, the excess demand will be denoted by gi¢p). When the price vector isp, the sign of gi(p) indicates whether the total demand for commodity i is greater of less than the total endowment ofthat good The following question arises naturally in the minds of most economists. Is it possible to find prices ofall commodities which ensure thatthe aggregate demand for each does not exceed the coresponding aggregate endowment? Prices with this property are called ‘equilibrium prices. This is because, if all consumers do face such prices, then all their demands for every good can be satisfied simultaneously. So there are no unfulfilled demands that can force consumers to change their plans «Pp denote such an equilibrium price vector. By definition, it must satisy the inequalities g,(p") < 0 for i= 1, ...4. It will now be shown how Brouwer’s fixed point theorem can be used to prove existence of an equilibrium price vector, proved suitable continuity conditions are imposed, ‘Toproceed further requires a litle extra notation, For each consumer j and commodity i, Jet w/ denote j°s initial endowment of i, and x/ (p) the same consumer's final demand when the price vector isp. In addition, let and as(p) = Do xfip), i denote respectively the total endowment and-market cemand for each commodity i. The latter is equal to the total demand for commodity 1 by all consumers. The excess demand functions referred to above are then given by BB) = (0) — wi = Now, the total value of consumer j's initial endowment at the price vector p is 37! piw}. so the budget constraint is Dlr = YL piu! aw it ‘This is valid for each consumer, so summing (1) from j = 1 to j = m and using the definitions of the aggregates wy and x;(p), we obtain Lp) =o piw; Walras’s Law) @ = ‘Thus, the value of the aggregate excess demand vector g/(p) = Tf. (x(P) ~ wi) at prices is identically zero, ‘An equilibrium price vector p* is characterized by the inequalities 2p") Swi or gi(p") $0 forall an @)SECTION 14.5 / EQUILIBRIUM IN A PURE EXCHANGE ECONOMY 517 so that the equilibrium market demand for each commodity does not exceed the total ex dowment of that commodity. Also, observe that because p* > O and x(p") = wr, each product p}(x:(p") — w,) is <0. But the sum over f = 1, ...,» ofall these products is 0 because of Walras’s Law (2). Consequently, itis impossible that p?(xj(p") ~ wi) < 0 for any i. Hence, we have proved that if p* is an equilibrium price vector, then Pt ” “This isthe rule of free goods: if any commodity isin excess supply in equilibrium, its price must be ero, In other words, ifthere is a commodity for which the market demand is strictly less than the total stock, then the equilibrium price fr that commodity must be 0. 11 is rather obvious that only price ratios, or relative prices, matter in this economy. For this reason, we ean normalize by dividing the price vector p by the (positive) sum pi-t--»+ py ofthe prices to ensure that this sum is equal to 1 (see Problem 1). Then all normalized price vectors will lic in the simplex A“! defined by (14.4.2). Any existence proof requires continuity assumptions. It will be enough to assume that the market demand functions p> x)(p), i = 1, -.., m, are continuous functions on the simplex A"~' or, what amounts to the same thing, that the excess demand functions gi, ..., ‘ga are continuous on A"~!, Our problem can now be stated as follows: Suppose that g\, ..-» &» are continuous on A"! and assume that Siew) =0 forall p ind! 6) Is there a vector p* = (P}.--. Pi) in A* such thar BP) 50, 2, galt) 50? (Note that (5) is a restatement of Walras’s Law.) ‘We shall use Brouwer's theorem to prove existence. To do so, we construct a continuous ‘mapping of A"? into itself for which any fixed point gives equilibrium prices. Consider first the mapping (p,.... Pa) +> (Phy -+-+ Py) defined by PLS Pita, P= Prt a2D os Pat So(P) © This simple price adjustment mechanism has a certain economic appeal it maps p:, the old” price of commodity i, to the new adjusted price p| = pj + gi(p). If excess demand {(P) is positive, so that the market demand exceeds the total available endowment, then the price is increased. The opposite is tre if g,(p) < 0, when the price is lowered. So far, this is all ery sensible, Note, however, that there is no guarantee that p > 0, Moreover, the new prices p; usually will not sum to 1. Hence, the new price vector (p..--» p) will not necessarily belong to the simplex A"~'. AS a consequence, Brouwer's theorem does not apply to the mapping defined in (6). The mapping must be altered somewhat in order to work Before we present an altemative mapping, recall that if x isa real number, then max(0, x) denotes the larger of the wo numbers Oand.x. Hence, if > Othen maxt(0, x} = x, whereas518 PROBLEMS’ FOR'SECTION 14.5 CHAPTER 14 7 CORRESPONDENCES AND FIXED POINTS max(0, x) = Oif x < 0. Itis easy to check that max(0, x the function x +> max{0, x) is continuous. With this in mind, instead of (6) we define « mapping (p1,-.-, Pe) > (PIs +--+ Ph) by $+ bxD, which shows iit Pi am + max (0. g:(p)}), where d(p) = 1+ Sf. max(0, u(p)) > 1. Its difficult to provide a good economic ‘motivation for this particular mapping. Nevertheless it does what is needed, Note first that pi > O forall . Also, the new prices p! sum to unity whenever the old prices p; do. Hence, (7) defines a mapping of A"! into itself. We see, moreover, that each p{ is a continuous function of (p), .... ps). Thus Brouwer's theorem applies, and so there must exist a fixed point p* = (pj... pf) in A*!, Atp*, for any i one hes eae “a This is easily seen to be equivalent ro ” oO p (of + max(0, g:(B"))) (d(p") — Dp} = max (0, ext") (8) ‘The definition of d(p) implies that d(p*) = 1. Suppose that d(p*) > 1. Then (8) implies that for those i with p? > 0 one has max(0, g:(p")} > 0, and so gi(p") > 0. Because pi-+--+ pt = Ishowever, a least one pf is positive. It follows that 5%, pf'gi(p*) > 0, «2 contradiction of Walras’s Law. Hence, we conclude that (ps) = 1. But then (8) implies that max(0, gi(p")} = 0 for i em.and so gi(p") = 0 for +n. This proves that p* is an equilibrium price vector. The existence ofan equilibrium in the pure exchange economy is thereby established. Brouwer's fixed point theorem can only be used to prove existence. For the last example in particular, it does not by itself indicate any practical method for finding equilibsium prices. The economie model considered above was one of pure exchange inthe Sense that there ‘was no production of commodities. Moreover, consumer demand functions were single- valued, More realistic equilibrium models include producers as well as consumers, and allow (multi-valued) demand (and supply) correspondences. Obviously, existence of an equilibrium is an important issue in these more general models as well. It turns out that existence can still be established under suitable assumptions, making use of Kakutani's fixed point theorem for correspondences. 1. In the pure exchange model studied above, suppose that each consumer j’s demand functions x{(p).....x4(p) result from utility maximization subject to's own budget constraint, Explain why the demand functions x/ (p) are then all homogeneous of de- sree 0, and why this entitles us to normalize prices by setting p +--+ py = 1.