Working Paper: CEPR ID: DP1403
Authors: Jess Benhabib; Roger E. A. Farmer
Abstract: We introduce mild increasing returns to scale into a version of the Real Business Cycle model. These increasing returns to scale occur as a consequence of sector-specific externalities, that is, externalities where the output of the consumption and investment sectors have external effects on the output of firms within their own sector. Keeping the production technologies for both sectors identical, for expositional simplicity, we show that indeterminacy can easily occur for parameter values typically used in the real business cycle literature, and in contrast to some earlier literature on indeterminacies, for externalities mild enough so that labour demand curves are downward sloping.
Keywords: sunspots; indeterminacy; business fluctuations
JEL Codes: E00; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sector-specific externalities (D62) | upward sloping labor demand curve (J20) |
| upward sloping labor demand curve (J20) | multiple equilibria (D50) |
| modest values of externalities (D62) | indeterminacy (D89) |
| investor beliefs (animal spirits) (G41) | economic fluctuations (E32) |
| increasing returns (I26) | more than proportional increase in output (E23) |
| indeterminacy (D89) | implications for economic policy (F68) |