Imperfect rationality, macroeconomic equilibrium and price rigidities

Giuseppe Ciccarone and Francesco Giuli
Authors registered in the RePEc Author Service: Enrico Marchetti

No 183, Departmental Working Papers of Economics - University 'Roma Tre' from Department of Economics - University Roma Tre

Abstract: We introduce some elements of Prospect Theory into a general equilibrium model with monopolistic competition in the good market and real wage rigidities due to (right to manage or efficient) wage bargaining, or to efficiency wages. We show that, under these types of labor market frictions, an increase in workers’ loss aversion: (i) reduces the equilibrium wage and in this way increases potential output; (ii) induces workers to work and consume less and in this way decreases potential output. If the former effect is greater (smaller) than the latter one, loss aversion increases(decreases) potential output. We also show that, under all the types of labor market frictions we consider, if loss aversion reduces equilibrium output, it also enhances the plausibility of nominal price rigidities.

Keywords: Macroeconomic equilibrium; Prospect theory; Behavioral economics (search for similar items in EconPapers)
JEL-codes: D03 E20 (search for similar items in EconPapers)
Date: 2013-09
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:rtr:wpaper:0183

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