Imperfect competition,Aggregate
demand and Business Fluctuations
Piero Ferri
Department of Economics “H.P. Minsky”
University of Bergamo - Italy
The relatioships between the topics
Imperfect competition: the role of
demand in micro and macro.
 The role of AD in macro in an uncertain
environment
 Medium run and the Fluctuations

The Tenets of IKE
Imperfect competition: its macro role has
been limited by two assumptions:
symmetry and rational expectations.
 The tenets of the IKE (imperfect
knowledge):
 Uncertainty in a changing environment,
 Difficulty in making forecast

THE CONSEQUENCES
Heterogeneity: differences with other
approaches
 Bounded rationality
 Norm behavior
 Consequences on the aggregate macro
supply.

THE ROLE OF AGGREGATE
DEMAND
The role of aggregate demand in
macroeconomics according to Blanchard
(2008).
 Microfoundations versus justification of
real and monetary rigidity.
 The role of indebted consumer in the
model
 Its relationship with labor share

The model

There is interdependence between supply
and demand aspects
Interdependence between real and
monetary aspects
Nonneutralities a la Akerlof

A medium-run perspective

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Some methodological aspects
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In studying the dynamics, we refer to RS methodology.
Regime 1 : bad state (high debt) and regime 2 virtuous state (low
debt)
Threshold: g (th)
Changes: steady state of income distribution: 01 >02 and
parameter  in the price of raw material.
•
Expectations: there is a learning process by means of Recursive
Least square.
Aggregate demand and the worker borrower
 1   mt 
Rt d t
g t  it  c1 1  Et g t  c2  c3
 1  m0 j * 

1  Et t
1

E

t t 


dt 

d t 1 1  Rt 1 
it 1

 1  t 1 
1  gt 1 1   t 1  1  gt 1 
it  1  2 Egt 3 (rt  r0 j )
The Supply side
 t   1 ut  u *    (1 Et t  (1  1) t 1 )  (1   ) mt
 mt   mt 1 1  gt 1 
Endogenous productivity

In the present case, the pivotal equation is represented by the
productivity equation:
tj = 1j + 2 gk t
where j= 1,2 and gk represents the rate of growth of capital.
The first component represents disembodied technical change,
while the second represents the embodied component.
The reason why it changes according to the regime, is to be
attributed to diffusion processes of technical change that
become more intense when aggregate demand is high.
Initially, the same behavior in the 2 regimes
The Specification of Endogenous Productivity
 tj   1 j   2 g kt
It
it 
Yt 1
g k ,t
It


K t 1
1  g k ,t
Kt
vt 
 vt 1
Yt
1  gt
g k ,t
it


vt 1
The Remaining Equations of the Model



Rt  R*j  1 E t   0  2 Egt  g 0

rt 
1  Rt 
1  E  
t
lt  lt 1
1
t
1  gt 
1   
ut  1  lt
Steady States and Regimes
Regime
d
π
g
1
2.29
0.0152
0.0113
2
2.26
0.019
0.0113
Recursive Least squares (RLS)
Let us suppose that agents are bounded
Rational. They try to learn the parameters
In particular, let us assume that learn the values of the parameters
By means of recursive least squares.
This technique is useful when one has changing parameters
.
Recursive Least square
y jt  b jt xt   jt j  1,...n
b jt  b jt 1   jt
y jt / t 1  b'jt 1 x^t
The Dynamics of the Model
u* = 0.08, 1 = 0.8
1 = 0.02,  11 = 0.008,
 12 = 0.008,  2 = 0.03
1 = 0.20, 2 = 0.35,
3 = 0.60, c1 = 0.40,
c2 = 0.405, c3 = 0.1 ,
1 = 1.80,  2 = 0.5,
01 = 0.75, 02 = 0.78 R*=
0.0051, theta1=0.95;
theta2=1.30; phi=0.7
Imperfect competition and income
distribution
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Initially Exogenous
In the benchmark case, labor share 1< labor share 2.
With the opposite hypothesis, the structural stability of the
system is maintained.
More flexibility is introduced if income distribution is
endogenous: (see Rotemberg and Woodford, 1996)
t =(t-1)*(1 -  (m(t-1) - m0j)))
Fig.2 shows the relationship between growth and income
distribution in the case that 01 > 02 and =-0.1.
All this implies that globalization and technical change can be
made compatible with a variety of income distribution patterns.
The Role of Endogenous Income Distribution
Conclusion





The medium-run, regime switching model, characterized
by an interdependence between demand and supply
factors, has shown how fluctuations can be generated
The results depend on the existence of a relationship
between consumption, income distribution and debt.
From a technical point of view, RS is at the root of the
dynamic behavior.
Imperfect competition has a fundamental role in justifying
the equations.
It is shown that there cannot be strict microfoundations
Perspectives
Different ways towards further
developments:
 Abandon
the reduced form for the
endogenous income distribution.

This implies considering also the labor
market equations.
 Blanchard
(2008)