Competitive Efficiency Wage Models with Keynesian Features

By Charles M. KahnDilip Mookherjee
1986| Working Paper No. 901

Competitive general equilibrium models with efficiency wage features are used to analyze some Keynesian propositions. The models are characterized by fully optimizing agents, flexible prices, competitive markets, and absence of demand uncertainty or credit constraints for firms. Each has a unique competitive equilibrium with underemployment in a sector (called manufacturing) with efficiency wages, relative to a self-employment sector. In the former sector, workers are typically laid off involuntarily, and jobs may be rationed. Since our models have flexible prices, the multiplier of manufacturing output with respect to autonomous demand changes may or may not exceed unity: demand changes lead to price effects as well as income effects that work opposite each other. Nevertheless, there always exist government policies that achieve Pareto improvements by switching demand towards the manufacturing sector. Optimal demand switching policies are explicitly characterized. We show that the size of the multiplier need have no relation to the size of the optimal intervention, and the government should stabilize the economy with respect to technology shocks more actively than to demand shocks.