A decentralized approach to general equilibrium analysis

Abstract

In this paper we develop a decentralized zero growth version of the model in King, Plosser and Rebelo (1988). By zero growth model we mean a model where physical output is constant in the steady-state. Note that, for the purposes of simulation, King, Plosser and Rebelo also transform their exogenous growth model into a model which is essentially a zero growth model. Our use of a decentralized version can also be explained. First, with a decentralized approach the assumptions we are using and their role become clearer. For example, with a Constant Returns to Scale production function the number of households and the number of firms is not important in terms of describing the equilibrium behaviour of the economy. But we may want to try other technologies. Second, the decentralized approach is more general. It can be used even when the assumptions of the second welfare theorem do not hold. Imperfect competition and distorting taxation are examples of realities which cannot be tackled using the second welfare theorem. In the model we construct, there are only two types of economic agents: households and firms. It is also important to note from the outset that we only have real variables in the model.