Other Microeconomic Ingredients
Besides sticky prices, another market imperfection built into most New Keynesian models is the assumption that firms are monopolistic competitors. In fact, without some monopoly power it would make no sense to assume sticky prices, because under perfect competition, any firm with a price slightly higher than the others would be unable to sell anything, and any firm with a price slightly lower than the others would be obliged to sell much more than they can profitably produce. Therefore, New Keynesian models assume instead that firms use their market power to maintain their prices above marginal cost, so that even if they fail to set prices optimally they will remain profitable. Many macroeconomic studies have estimated typical firms' degree of market power, so this information can be used in parameterizing New Keynesian models.
Other microeconomic elements that appear in some New Keynesian models (though not so commonly as sticky prices and imperfect competition) include the following.
- Credit market imperfections
- Coordination failures, leading to aggregate demand multipliers and possible multiplicity of equilibrium
- Unemployment caused by moral hazard problems, or unemployment caused by matching frictions
Read more about this topic: New Keynesian Economics
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