Sunspot equilibrium

In economics, a sunspot equilibrium is an economic equilibrium where the market outcome or allocation of resources varies in a way unrelated to economic fundamentals. In other words, the outcome depends on an 'extrinsic' random variable, i.e. on some random influence that matters only because people think it matters. The sunspot equilibrium concept was defined by David Cass and Karl Shell. Cass and Shell also coined the term 'sunspots' as a suggestive and less technical way of saying 'extrinsic random variable'.

Knowledge of sunspots on the sun is old but the current meaning of 'sunspots' in economics is recent. In the 19th century, some economists researched whether sunspots might have a real effect on weather and agriculture and thus on prices. In other words, they proposed that sunspots might be fundamental influences driving the economy. The modern use of the term 'sunspots' is instead related to the question of how an observable signal that is unrelated to fundamentals could nonetheless have an impact on prices. The theory emphasizes that a nonfundamental variable might have an effect on prices if it influences 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.