Market Imperfections: Basic Integration and Comparison

Abstract

Whereas the non-Walrasian approaches considered in the preceding chapter were mainly concerned with a correct description of short-run rationing equilibria on the basis of temporarily given wages and prices, they usually left open the question, how these wages and prices are actually formed and why they are temporarily fixed. Partly as a reaction to this unsatisfactory situation a large number of theories emerged, that tried to give some foundation for these assumptions by explicit consideration of imperfections on the markets for labor or for goods (or both) . Although theories of price formation under imperfect competition on the one hand and macroeconomic models based on price setting or non-market clearing prices both have a long tradition, attempts to integrate both lines have occupied a larger part in economic literature only recently during recent decades. They resulted in a variety of mainly microfounded models of general equilibrium, in which prices were derived from optimizing behavior of agents endowed with some market power. In the following some of these approaches1 shall be briefly sketched, because they provide the background for the aggregative equations employed by Carlin and Soskice (1990) in their basic imperfect competition model, that will later be integrated into the KMG framework. As one main element of the latter is the existence of involuntary unemployment, the question arises, how the non-market-clearing wages, which are mainly responsible for this, are generated. On the other hand, the formation of the prices for goods plays an important role when judging the potential effect of changes of aggregate demand on output.