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Question from Past Macroeconomics Qualifying Exam (Fall, 2005 - Question one) at George Mason UniversityEdit

There is a small but growing macroeconomics literature of a game-theoretic, non-Walrasian nature that treats coordination not as an assumption, but as a condition, to be modeled and explained. The Stag Hunt game, illustrated below, has been utilized in this respect. In this game, individuals choose an effort supply E = 1 or 2. Complementarity in production is generated by the assumption that there is equal consumption per capita, governed by the minimum supply of effort.

Box

Evaluate the use of such modeling techniques for explaining non-Pareto-equilibrium (i.e., equilibrium with involuntary unemployment).

AnswerEdit

This game is not dominance solvable but has two Nash equilibria, i.e. (1,1) and (2,2). The expected payoff from playing either strategy (1 or 2) is 1 for both players and both players playing 1 could therefore be an equilibrium. The (1,1) equilibrium is however paretor-inferior to the equilibrium at (2,2) and could represent a suboptimal macroeconomic euqilibrium with involuntary unemployment. This game implies that government intervention to move the economy to the pareto-superior equilibrium could be justified.

Keynesian Economics suggested that the economy could be stuck in a pareto inferior equlibibrium situation with involuntary unemployment and suboptimal output. This game could be interpreted as suporting the assumption of Keynesian Economists that government intervention could improve a suboptimal macroeconomic situation and move the economy to the superior equilibrium.

  • Stag == bigger payoff (must have coordination to catch a stag)
  • Rabbit == smaller payoff (can catch rabbits individually, without coordination, but it is a smaller meal)

A somewhat more tenuous argument might be to say that the problem in this game is a lack of a commitment mechanism ex ante. This may represent transactions costs. Involuntary unemployment requires some transactions costs. For example, and you can then talk about Efficiency wages (TC = information costs), Implicit contracting (TC = lack of complete contracts).

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Other QuestionsEdit

This macro-stub needs improving.

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