Continua of Underemployment Equilibria

In this paper the existence of unemployment is partly explained as being the result of coordination failures. This is achieved by considering a standard general equilibrium model and splitting the set of commodities in two groups. The first group contains commodities like gold. The prices of these commodities are fully flexible, even in the short run, and their markets always clear. The prices of the commodities in the second group are rigid in the short run (for instance labor services or some consumer goods), and households and firms may expect restricted supply possibilities. We show that such expectations are self-enforcing, even if all prices of commodities in the second group are competitive. In that case it is shown that as a result of coordination failures a continuum of equilibria results, among which an equilibrium with approximately no trade in the commodities of the second group, and a Walrasian equilibrium. In fact, these coordination failures also arise at other price systems, but then unemployment is the result of both a wrong price system and coordination failures. Moreover, some properties of the set of equilibria are analyzed. Generically, there exists a continuum of non-indifferent equilibrium allocations. Under a condition implied by gross substitutability, there exists a continuum of equilibrium allocations in the neighborhood of a competitive allocation. Examples show that the latter property may not hold in general