Increasing Returns to Scale and Welfare: Ranking the Multiple Deterministic Equilibria

CER-ETH Center of Economic Research at ETH Zurich, Working Paper No. 08/99

21 Pages Posted: 16 Oct 2008

See all articles by Mauro Bambi

Mauro Bambi

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Aurélien Saïdi

Université Paris Nanterre

Date Written: July 25, 2008

Abstract

We consider a real business cycle model with a productive externality and an aggregate non-convex technology set a la Benhabib and Farmer embodying capacity utilization, which exhibits indeterminacy of the steady state and multiplicity of deterministic equilibria under plausible values of the increasing returns to scale. The aim of the paper is to rank these different equilibria according to the initial value of consumption using both a linear-quadratic approximation, extensively explained by Benigno and Woodford [2006a, 2006b], and simulation methods. We study the implications of such a ranking in terms of smoothness of the welfare-maximizing trajectory and show that the welfare-maximizing consumption and labor paths are all the smoother since the level of increasing returns is low. At last, we show that this solution provides a good benchmark for judging the desirability of the stabilization policy proposed by Guo and Lansing [1997].

Keywords: Increasing returns, Local indeterminacy, Welfare analysis, Numerical Methods

JEL Classification: E32, E4, H61, O42, O47

Suggested Citation

Bambi, Mauro and Saïdi, Aurélien, Increasing Returns to Scale and Welfare: Ranking the Multiple Deterministic Equilibria (July 25, 2008). CER-ETH Center of Economic Research at ETH Zurich, Working Paper No. 08/99, Available at SSRN: https://ssrn.com/abstract=1285008 or http://dx.doi.org/10.2139/ssrn.1285008

Mauro Bambi (Contact Author)

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Aurélien Saïdi

Université Paris Nanterre ( email )

200 Avenue de la République
Nanterre cedex, Nanterre Cedex 92000
France

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