Abstract
This paper considers a general equilibrium model with incomplete financial markets where production sets depend on the financial decisions of the firms. In the short run, firms make financial choices in order to build up production capacity. Given production capacity firms make profit maximizing production decisions in period two. We provide the conditions of existence of equilibria.
Highlights
Classical general equilibrium literature on production with incomplete markets has focused on variations of the Arrow’s seminal two-period model with exogenous financial assets [1] [2]
Firms choose quantities of inputs of production in period one such that associated output choices in period two are optimal. This concept of the firm corresponds to the private ownership model of the firm introduced by Debreu [3], where the single argument of the firm’s two period sequential optimization function is the real activity vector
In these recent models, influenced by Drèze [4] and Grossmann & Hart [5], optimality of the choice of a net real activity vector over two periods refers to the average utility of the group of owners of the firm, the stock holders
Summary
Classical general equilibrium literature on production with incomplete markets has focused on variations of the Arrow’s seminal two-period model with exogenous financial assets [1] [2] In this framework, the firm’s real sequential optimization structure is independent of its financial activities. Firms choose quantities of inputs of production in period one such that associated output choices in period two are optimal This concept of the firm corresponds to the private ownership model of the firm introduced by Debreu [3], where the single argument of the firm’s two period sequential optimization function is the real activity vector. This paper introduces a model of the firm, where its financial and real activities are independent of any average utility of the stock holders It postulates that firms maximize long run profits and make financial and real decisions sequentially over two periods.
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