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Multiple equilibria: coordination failure and endogenous cycle

  • Amedeo Panci
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    An imperfectly competitive economy is considered were aggregate externalities are the source of multiple equilibria. In fact, the choice to adopt a higher productivity technique implies a lower price for the single market and a lower average price at an aggregate level. This results in a higher aggregate demand that carries an higher production with rising profits of firms. The analysis is conducted considering many differentiated firms that have to choose between two techniques: a constant returns to scale function and an increasing returns to scale function. The model is solved as a two stage game. In the first stage, firms simultaneously choose the technique of production. In the second stage they set their prices. Labour is the only factor of production, and the equality between labour demand and labour supply is a condition for the aggregate equilibrium of the economy. Prices and wages are flexible, but different values of the parameters in the model, imply totally different qualitative behaviours: one equilibrium, two equilibria, cycles. The co-ordination problem that arises in this framework makes it possible to have multiple equilibria even in the presence of perfectly flexible prices and wages.

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    Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 30.

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    Length: 31
    Date of creation: Jun 1999
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    Handle: RePEc:sap:wpaper:wp30
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