Involuntary Unemployment and Imperfect Competition: A Game Theoretic Macro Model

Involuntary Unemployment and Imperfect Competition: A Game Theoretic Macro Model

1986Working Paper No. 880

This paper considers a game-theoretic, non-Walrasian, general equilibrium model of price determination, production, and exchange. In this game, firms first select prices and wages, consumers/workers then make input supply and output demand offers, and finally firms select the fractions of these to accept. Equilibrium (pure strategy, subgame perfect Nash equilibrium) involves each agent's acting optimally from each point forward while correctly recognizing the results of taking any given course of action. In particular, firms correctly forecast the quantity responses to different prices and wages. It is shown that with a particular structure of preferences, endowments and technology, if an equilibrium exists with positive levels of economic activity, then there exists another equilibrium at the same prices and wages with lower levels of activity. The latter equilibrium corresponds to involuntary unemployment. This unemployment arises because of a failure of excess demand. Given the prices and wages, no firm expects enough demand to justify greater hiring. Thus, employment, income and demand are low, and the pessimistic expectations are confirmed. Further, expectations are such that price and wage changes do not appear profitable, and, by the nature of equilibrium, these expectations are correct.