Strategic Consumption Complementarities: Can Price Flexibility Eliminate Inefficiencies and Instability?

Generally, two facts occur with strategic complementarities and fixed prices: i) the equilibria are multiple, and ii) if the complementarities are strong, the law of demand is violated and the equilibrium is unstable. In this paper, we analyse the effect of price flexibility on these features as well as on market welfare properties. Assuming an exchange economy with H agents consuming two goods with one strategic complement, we show that flexibility of prices may remove both the multiplicity of the equilibria and the instability of behaviour when the externalities are strong. The equilibrium with beneficial externality is shown to be Pareto optimal while the equilibrium with detrimental externality requires corrections