Sunspot equilibrium

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Sunspot equilibrium is a concept in economics invented by David Cass and Karl Shell. A sunspot equilibrium is an economic equilibrium where the market outcome or allocation of resources depends on an extrinsic random variable, or “sunspots” that matters only because people think it matters.

The term sunspots is old but the current meaning is recent. In the 19th century, research on the sunspot problem focused on the effect of a change in fundamental variables on prices. Among some of the fundamental variables were weather or agriculture. The modern problem is to determine how an observable signal with no influence on fundamentals can have an impact on prices. An observable signal can have an effect on prices via expectations.

The sunspot equilibrium framework supplies a basis for rational expectations modeling of excess volatility (volatility resulting from sources other than randomness in the economic fundamentals). Proper sunspot equilibria can exist in a number of economic situations, including asymmetric information, externalities in consumption or production, imperfect competition, incomplete markets, and restrictions on market participation.