The Market-Power Foundations of Macroeconomic Policy

Abstract

THE PREDOMINANT THEORY of markets, namely the Walrasian or Arrow Debreu model of general competitive equilibrium, implies that unemployment never appears and that economic policy never has universally good effects. First, it postulates that the supply and demand by price-taking agents equilibrates in the market for any commodity, including labor. Hence, no unemployment occurs. Second, Walrasian equilibria are efficient, as anticipated by Adam Smith's invisible hand, and as precisely stated by the first fundamental theorem of welfare economics. (Efficient is synonymous with Pareto optimal.) Thus, either economic policy has no effects or it hurts some group of citizens. The first fundamental theorem does require some substantive conditions, such as complete markets and the absence of physical externalities.' It is nevertheless a powerful result, because it indicates that, except for distributional concerns, the public interest is well served without the need for cooperation, coordination, or public intervention, as long as all economic agents are price takers. Situations that seem to call for some form of coordination, as the presence of multiple equilibria or of complementarities in production, are in fact covered by the theorem. The possibility of multiple equilibria is totally natural not only in the Walrasian system but, more generally, in any model defined by a system of nonlinear equations. For instance, Walrasian as well as oligopolistic models may well have three equilibria, one of which has high wages and low employment, whereas another one has low wages and high employment.

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