This book arose out of the seventeenth Summer Workshop held at Warwick University on 12–30 July 1993, with the same title as this volume. We had felt for some time that there was a need for a conference to bring together some of the people involved in the study of various ‘market imperfections’ and their implications for macroeconomics. We had become aware of the rapidly burgeoning literature in the particular area of imperfect competition and macroeconomics in the course of writing our survey (Chapter 2 in this volume) over the period 1988–91. We wanted to organize a conference that would explore this along with other topics: financial market imperfections, bounded rationality, and menu costs, to name but a few. The idea coalesced with some encouragement and prodding from Marcus Miller, and our idea was generously funded by the Economic and Social Research Council of the UK, and by the Human Capital and Mobility Programme of the EU Commission.

The workshop was a great success, and we would like to thank all those who came for making it so. All of the contributors to this volume attended the workshop. The papers appearing here were either given at the workshop, or were ‘commissioned’ there specially for the volume, with the exception of two reprints (Chapters 2 and 4) which are included because they particularly complement the general theme.

Introduction

The importance of imperfect competition has long been recognized in many areas of economics, perhaps most obviously in industrial economics and in the labour economics of trade unions. Despite the clear divergence of output and labour markets from the competitive paradigm in most countries, macroeconomics where it has used microfoundations has tended to stick to the Walrasian market-clearing approach. However, over the last decade a shift has begun away from a concentration on the Walrasian price-taker towards a world where firms, unions and governments may be strategic agents. This chapter takes stock of this burgeoning literature, focusing on the macroeconomic policy and welfare implications of imperfect competition, and contrasting them with those of Walrasian models.

We seek to answer three fundamental questions. (1) What is the nature of macroeconomic equilibrium with imperfect competition in output and labour markets? With monopoly power in the output market causing price to exceed marginal cost, and union power leading to the real wage exceeding the disutility of labour, we would expect imperfectly competitive macroeconomics to have lower levels of output and employment than Walrasian economies, a Pareto inefficient allocation of resources, and the possibility of involuntary unemployment. Few would disagree that deviations from perfect competition will probably have undesirable consequences. (2) To what extent can macroeconomic policy be used to raise output and employment in an imperfectly competitive macroeconomy? (3) If policy can raise output and employment, what will be the effect on the welfare of agents?

Introduction

The concept of the natural rate of unemployment was formulated in 1968, by Friedman and Phelps. In Friedman, it plays the central role in his theory of the relationship between short-run and long-run Phillips curve. However, in this chapter, I will focus not on its role within the theory of inflation per se, but rather on the fundamental notion of equilibrium, the natural rate itself. The natural rate stands in a tradition of ideas that may be loosely called classical or monetarist. We may well ask, therefore, two questions: first, how does the idea of the natural rate (NR) differ from its predecessors; secondly, how have more recent ideas developed or diverged from it? A full and proper answer to both of these questions would require a degree of scholarship and comprehensive grasp of the broad sweep of the history of economic thought which, alas, eludes me. However, I intend to approach both questions in terms of a series of snapshots and observations which will be drawn together towards the end of the chapter. Without spoiling the story, I conclude that the natural rate as an equilibrium concept was largely derivative of Patinkin's concept of full employment, as laid out in his Money, Interest and Prices (first published in 1956). However Friedman nowhere ever lays down a specific theory of the natural rate itself, and as such the concept has proven sufficiently loose and vague to fit a variety of subsequent models of equilibrium.