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Abstract:
This paper is about the viability of competitive equilibrium under increasing returns to scale technologies in a finite-horizon production economy that operates with the help of money. We argue that presence of cash-in-advance constraints in input markets eliminates the problem of unbounded factor demands. We introduce some restrictions on utility and production functions to ensure that the first-order necessary condition (Euler equation), for the optimization problem of a producer with non-concave objective function, is also sufficient. We then derive a condition on the growth rate of money which is both necessary and sufficient for the existence and uniqueness of a stationary monetary competitive equilibrium. We fully characterize the equilibrium and provide a graphical procedure for conducting comparative statics. The effects of changes in money growth rate, number of firms, labor endowment and productivity on equilibrum prices and allocations are analyzed. We observe that Friedman's rule (or output maximizing money growth rule) is not necessarily deflationary. Furthermore we show that if producers are sufficiently patient, the optimal money growth rule implements the average cost pricing equilibrium, without any need for direct price
regulation.
Keywords: Friedman's rule, increasing returns, competitive
equilibrium, money.
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