Strategic Complementarity in Business Formation: Aggregate Fluctuations and Sunspot Equilibria

Abstract

The possibility of sunspot equilibria and endogenous cycles are explored in a two-sector overlapping-generations model with entry. It is shown that if prospective entrants act oligopolistically as producers but competitively as consumers then a strategic complementarity between the entry decisions of agents across sectors and across time may arise. If the complementarity is sufficiently strong, the economy will have multiple, Pareto-ranked steady states. Stationary sunspot equilibria can then be constructed as a randomization between allocations in the neighbourhood of the multiple steady states providing a source of aggregate fluctuations.