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The Price Normalization Problem in Imperfect Competition and the objective of the Firm

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Author Info

  • Egbert Dierker

    (University of Vienna)

  • Birgit Grodal

    (Institute of Economics, University of Copenhagen)

Abstract

General equilibrium models of oligopolistic competition give rise to relative prices only without determining the price level. It is well known that the choice of a numéraire or, more generally, of a normalization rule converting relative prices into absolute prices entails drastic consequences for the resulting set of Nash equilibria when firms are assumed to maximize profits. This is due to the fact that changing the price normalization amounts to altering the objective functions of the firms. Clearly, the objective of a firm must not be based on price normalization rules void of any economic content. In this paper we propose a definition of the objective of a firm, called maximization of shareholders´ real wealth, which takes shareholders´ demand explicitly into account. This objective depends on relative prices only. Real wealth maxima are shown to exist under certain conditions. Moreover, we consider an oligopolistic market and prove the existence of a Nash equilibrium in which each firm maximizes the real wealth of its shareholders.

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Bibliographic Info

Paper provided by University of Copenhagen. Department of Economics. Centre for Industrial Economics in its series CIE Discussion Papers with number 1998-08.

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Length: 31 pages
Date of creation: Oct 1998
Date of revision:
Publication status: Published in: Economic Theory. August 1999; 14(2): 257-84
Handle: RePEc:kud:kuieci:1998-08

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Keywords: price normalization problem; imperfect competition; oligopoly; firms´ objectives; real wealth maximization; profits and shareholders´ demand;

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