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nick i know it's unrelated, but you should respond to this. http://www.economist.com/blogs/freeexchange/2012/12/business-cycles-0

Lay out your view once again

Don't we want raised prices in a sticky-price model?

I know this is off topic, but I have been getting really, really slow response times at the WCI site lately. Is it just me?


Is my demand curve too elastic? ;)

JCE: thanks. I may have a go at it.

david: if we are in recession, we want firms to respond to an increase in AD by increasing Y rather than P. Yep, in that bit I was assuming we are in the current recession, and thinking about how best to get out of it.

Min: sometimes I get a slow response too. I don't know why.

Thanks, Nick. :)

Could it be this tweet stuff on the right?

Surely in a canonically microfoundational NK model, firms set their Y given prevailing/Calvo'd P? And the elasticity is generally assumed to be fixed? It is the increased P that induces increased Y, so to speak.

david: I disagree. In the standard New Keynesian model firms set P, and Y is determined by AD given that P. And at the individual firm level, the same is true.

Three-equation NK macro, the one with Calvo in it, has firms just take what P they are given. You can sustain the multiple equilibria with pure demand externalities and no adjustment costs - a la, a wimpy Calvo fairy - since the externalities first increase and then decline back to zero as the proportion of adjusting firms increases, so the stable equilibria are (as you describe) that no firms adjust or that all firms do.

But then why talk about Calvo? And the Calvo fairy doesn't even do much punishing here; adjustment costs are all pretty small for the argument to work at all, envelope theorem and all. There is no situation where the loss of market-share under mispricing is immense and yet firms remain monopolistically-competitive price-setters. It would certainly be Nash for all firms at one equilibrium to stay there, but their losses from deviating slightly are small - businesses do take GST hikes and so forth as opportunities to adjust relative prices. And real rigidities would weaken the multiple equilibria result (it becomes unambiguously harder to sustain the no-adjustment nominal anchor equilibrium).


"Three-equation NK macro, the one with Calvo in it, has firms just take what P they are given."

You lost me there. The Calvo Phillips Curve is based on the assumption that each period a fraction of firms can change their prices, and the remaining fraction can't. For firm i that can change this period, it chooses Pi taking the general price level P as given. That is how P changes over time.

"You can sustain the multiple equilibria with pure demand externalities and no [price?] adjustment costs - a la, a wimpy Calvo fairy..."

I agree. You *can* do that, if you assume the strategic complementarities are big enough, but I don't want to assume they are that big.

(I prefer "strategic complementarities" to "demand externalities", because externality means that my firm benefits if your firm increases output, but complementarity means that my firm's *marginal* benefit from increasing output increases if your firm increases output.)

I understand the "small menu costs" idea under monopolistic competition. A first order small deviation of relative price from the profit-maximising relative price causes a second order small loss of profit for an individual firm. In fact, my implicit model here is based on small costs of changing prices plus strategic complementarities. But you lost me on the rest of that paragraph.

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