The Price Index Effect and Macroeconomic Inefficiency

Abstract

In the Dixit-Stiglitz model of monopolistic competition the effects of individual pricing decisions on the aggregate price index are neglected. Tliis paper studies the implications of this approximation in terms of the efficiency of macroeconomic equilibria. We show that allowing for the price-index effect, makes the degree of inefficiency positively correiated with the number of agents; it also reduces the scope for New Keynesian outcomes, such as price rigidity and multiple equilibria.New Keynesian economies, aggregate demand externalities, nominal rididity