Rotemberg & Woodford (1995)

Title

Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets

Authors: Julio J. Rotemberg, Michael Woodford

NBER Working Paper No. 4502

October 1993

Acknowledgments

• Thanks to:

  • David Backus

  • Roland Benabou

  • Participants at the Frontiers of Business Cycle Research for their comments

  • Stephanie Schmitt-Grobe, Martin Uribe for research assistance

  • NSF for support

Abstract

• Introduction of imperfectly competitive product markets into neoclassical growth model.

• Focus on:

  • Consequences for fluctuations in aggregate economic activity.

  • Different market structures:

    • Monopolistic competition.

    • Customer market model (Phelps and Winter).

    • Implicit collusion model (Rotemberg and Saloner).

  • Review of empirical evidence for numerical calibration of models.

  • Analyze effects of various real shocks (technology shocks, shock to government purchases, market power).

  • Discuss self-fulfilling expectations.

Introduction

• Discusses the impact of imperfect competition on economies responding to business cycle shocks.

• Past literature primarily based on perfectly competitive firms.

• Argument for the importance of allowing for imperfect competition:

  • Necessary for equilibrium given increasing returns to technology.

  • Highlights cyclical changes in productivity.

Key Concepts in the Paper

1. Imperfect Competition

• Imperfect Competition's Importance:

  • Market power leads to price above marginal cost.

  • Increases returns make understanding business cycles challenging.

• Effects on Shocks:

  • Traditional views may misinterpret government purchase increases as technical progress.

2. Returning to Neoclassical Assumptions

• Pure Profits and Market Power:

  • Justifies absence of pure profits in the U.S. economy.

  • Significance of internal vs. external increasing returns.

3. Endogenous Component of the Solow Residual

• Imperfect competition modifies interpretation of Solow residual, generally thought of as a tech shock measurement.

• Positive Solow residual noted even with increased government purchases.

Implications of Imperfect Competition

• Changes in markup can affect labor demand and pricing strategies:

  • Markup Changes and Labor Demand:

    • Price changes lead to shifts in employment patterns and perceived economic productivity.

  • Role of government intervention and spending boosts under imperfect conditions.

4. Self-Fulfilling Expectations

• Possibility for rational expectations equilibria to derive shifts unrelated to changes in underlying economic fundamentals.

• Allows emergence of multiple equilibria under certain parameter specifications.

5. Summary of Results

• Empirical data suggests that ignoring imperfectly competitive product markets can lead to significant inaccuracies in economic modeling.

• Requests further research to explore and calibrate these imperfect market conditions in economic fluctuations.

Conclusion

• Imperfect competition critically impacts economic response to various shocks, recounting significant deviations from established economic laws in perfectly competitive frameworks.

• Establishes necessity for more nuanced approaches to aggregate fluctuations that incorporate these influences.