Equilibrium Selection in Imperfectly Competitive Economies with Multiple Equilibria

This paper investigates the selection of an equilibrium in an economy with multiple, Pareto-ranked, Nash equilibria. A history-dependent selection criterion is proposed which induces correlated behavior in equilibrium even though agents are playing one-shot games and disturbances are not correlated over time. The model economy may experience prolonged periods in which a low productivity technology is in use and then, as a consequence of a large real disturbance, may switch to an alternative equilibrium in which a high productivity technology is utilized. Thus the model qualitatively matches observations of serially correlated movements in output and employment and generates procyclical productivity though there are no exogenous technology shocks. Copyright 1994 by Royal Economic Society.

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