Multiple Equilibria and Interfirm Macro-Externality: An Analysis of Sluggish Real Adjustment

In an imperfectly competitive economy, a continuum of equilibria at the firm level exists under certain analytical conditions (Ng 1986). Extending the earlier analysis of a representative firm, this paper shows that even if the condition for a continuum of equilibria is not exactly satisfied, the factors of price-adjustment costs, interfirm heterogeneity, and macro-externality can cause the economy to be stuck at the quasi macroequilibria after aggregate demand experiences a contractionary shock. Although adjustment costs are small and gains from adjustment are potentially large, the adjustment tends to be sluggish due to the existence of interfirm macro-externality.