Chaotic price dynamics, increasing returns and the Phillips curve

Abstract

Chaotic behavior of prices can emerge as a robust result from a very simple and standard price adjustment process. Consider the dynamics of prices adjusting according to supply and demand in economies with increasing returns to scale. Increasing returns in production implies the existence of a globally attracting set of prices, containing a stable disequilibrium price, within which the motion of the system is chaotic. This property holds for any step size in the price adjustment process when consumption and leisure are complementary. We prove that long-run statistical properties of the system's behavior in this set are described by an ergodic measure. Price dynamics drive the system into the globally attracting region, and then chaotic motion takes over. On average according to this measure there is excess supply. We suggest possible empirical implications of our analysis, particularly with respect to the relationship between wages changes and the demand for labor, the “Phillips curve”.