Imperfect Competition and Price Stability in General Equilibrium

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This project addresses two major gaps in general equilibrium theory: a full treatment of monopolistic competition and an explanation of the convergence of prices towards their equilibrium values. These are fundamental and as yet unresolved problems in economic theory. The insights from this project should improve the basic paradigm used by economic theorists to study market performance. Imperfect competition is modelled by taking firms to be "moderately small," although not so small the situation is essentially perfectly competitive. "Smallness" should be defined endogenously, by free entry in large markets, not by assuming that firms having rising average cost curves after a point. Prices are chosen by firms, but production requires time so that the competition is effectively Cournot-like. Stability theory has to be reconsidered as a learning process. Prices should be formed by firms making rational decisions. This is made possible by recognizing that out of equilibrium either sellers or buyers have market power. There is incomplete information. Each round yields a set of signals in the form of excess supplies or demands for individual firms. From this they can update their priors on the unknown parameters of the economy. In the next round, they choose production before the market opens and also choose new prices. Since the process is one of cumulative information (past signals still enter into present decisions), the failure of standard stability theory may not prevent better results in convergence.