Dynamic Behavior of Imperfectly Competitive Economies with Multiple Equilibria

Abstract

This paper investigates the dynamic behavior of an economy with multiple Nash equilibria. The first part of the paper analyzes an abstract game exhibiting multiple equilibria. A history dependent selection criterion is proposed which induces correlated behavior in equilibrium even though agents are playing one-shot games and disturbances are not correlated over time. The second part of the paper investigates a specific model of multiple equilibria. Here the multiplicity is induced by the presence of a discrete decision on the part of firms regarding their choice of technique. The implications of the selection criterion introduced in the first part of the paper are illustrated through this example. Again correlated behavior emerges in a sequence of independent one-shot games. The model economy may also experience prolonged periods in which a low productivity technology is in use and then, as a consequence of a large real disturbance, may switch to an alternative equilibrium in which a high productivity technology is utilized. The paper also discusses the Pareto ordering of these equilibria.