which an agent would be willing to undertake an exchange at the prevailing price, but it is
not allowed to do so ex imperio, i.e. as a result of a prohibition by the authorities. Com-
mon examples are import quotas or voluntary export restraints, entry barriers, politically or
ideologically motivated restrictions etc. Similarly, by involuntary participation, we refer to
situations where agents would not be willing to engage in a transaction given the prevailing
price, but are forced to do so by government fiat, as was often observed in centrally planned
economies. The consequence of involuntary participation/exclusion is similar to the foreclo-
sure of the domestic market to foreign competition: excessive demand (or supply) in the first
period can co-exist with the post-liberalization price reduction (or increase respectively).
Indeed, Proposition 2 can be extended to include situation in which the original govern-
ment intervention involves both price setting and a general form of involuntary participa-
tion/exclusion. Let Se and Df respectively be the total supply and demand by agents who
either involuntarily or voluntarily engage in transactions under the status quo. We illustrate
these functions in Figure 4 where we assume for simplicity that all users choose voluntarily
whether to transact. In Figure 4, some producers with very high marginal cost are forced
to supply in the status quo. These producers are represented by the leftmost portion of Se.
The rest of the producers, represented by the monotonic portion of Se, make supply deci-
sions voluntarily. This is a typical phenomenon in a centrally planned economy, where the
government may order high cost producers (such as state-owned enterprises) to deliver the
commodity simply because it has no knowledge of their true marginal cost (Lau, Qian, and
Roland (2000)). Lacking information on the fundamentals of the economy, the planner sets
the price at an arbitrary level P which in our example happens to generate an excess supply,
in the sense that Se(P) > Df(p). Notice that the free-market price Pe that prevails in the
market track in the second period bears no relationship with the price at which S = D.
This is because an arbitrary number of producers are involuntarily forced to participate in
transactions due to the original government intervention.
Since Pe and the price at which Df = Se are not related, it becomes possible for Pe > P
while Se(P ) > Df(P ). When Pe > P , intertemporal arbitrage implies that the supply will
decrease and the demand will increase in the first period. However, because Se(P ) > Df(P),
it is possible for the first period voluntary transaction to expand as a result of this arbitrage,
and hence Qe 1d > Qe . Since the increment in transaction is voluntary and the first period
price is fixed, there must be a Pareto improvement. A fortiori, the anticipated dual track
13