A dynamic macroeconomic model with price setting firms

Abstract

The perfectly rational approach of the previous chapter (firms know the objective demand curve and households make perfect price forecasts) turned out not to determine unique intertemporal equilibria. To select among such equilibria by learning, it is not very promising to maintain the assumption of a temporary objective equilibrium in each period, and thereby to suppose perfectly rational firms. This is for two reasons. First, as shown in 4.3.4, there is a continuum of stationary equilibria and it depends crucially on the learning process of price expectations which equilibrium is attained. Thus, “learning” cannot be expected to provide a true selection of equilibria. Second, temporary objective equilibria may not exist, even if the usual assumptions on preferences, technologies and expectation functions are imposed which are sufficient for existence of temporary competitive equilibria. Thus, a globally defined dynamics cannot be expected to exist, and even if it exist, it need not be computable.

“In the last case (of decreasing returns) there will be an indeterminate tract through which the index of value will oscillate, or rather will vibrate irregularly for an indefinite length of time.”

F.Y. Edgeworth (1897)

“Under conditions of disequilibrium, there is no reason that there should be a single market price, and we may very well expect that each firm will charge a different price.(…) the whole adjustment process is apt to be very irregular. Although the broad tendency will be for prices to rise when demand exceed supply, there can easily be a considerable dispersion of prices among different sellers of the same commodity, as well as considerable variability over time in the rate of change of prices.”

K.J. Arrow (1959)