DP280 | Imperfect Competition, Underemployment Equilibria and Fiscal Policy


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It is often claimed that the demand externality created by imperfectly competitive markets can provide an analytical basis for Keynesian fiscal policy prescriptions. Here this demand externality is embedded in a model where saving and employment are determined by optimizing choices in an imperfectly competitive setting. It turns out that underemployment equilibria do exist, that there is scope for fiscal intervention, but that Keynesian fiscal prescriptions are turned on their head. Demand externalities among imperfectly competitive firms do not in general provide a theoretical basis for these prescriptions, unless supplemented by other deviations from the Walrasian standard in the labor or capital market.