Multiple Steady States and Endogenous Fluctuations with Increasing Returns to Scale in Production

Abstract

The purpose of this paper is to study the influence of the elasticity of capital–labor substitution and of the labor supply elasticity on the existence of multiple Pareto-ranked stationary equilibria, local indeterminacy, bifurcations, and expectations-driven fluctuations in economies with external and internal increasing returns to scale in production. This is done through general geometrical methods that do not depend upon particular specifications for preferences and technology. For the sake of concreteness, the analysis focuses on the model with heterogeneous agents and financial constraints presented in Woodford (J. Econ. Theory40(1986), 128–137) and extended by Grandmont, Pintus, and de Vilder (“Capital–Labor Substitution and Competitive Nonlinear Endogenous Business Cycles,” CREST Working Paper 9728, 1997) to account for capital–labor substitution. Increasing returns to scale are incorporated in two different market structures: — an economy with aggregate production externalities and perfectly competitive markets, — an economy with increasing returns internal to the firm and imperfect competition in the product(s) market(s) only.Journal of Economic LiteratureClassification Numbers: C61, E32.