Coordination failure (economics)
Encyclopedia
In economics coordination failure is a concept that can explain recessions through the failure of firms and other price setters to coordinate. In an economic system with multiple equilibria
, coordination failure occurs when a group of firms could achieve a more desirable equilibrium but fail to because they do not coordinate their decision making. Coordination failure can result in a self-fulfilling prophecy
. For example, if one firm decides a recession is eminent and fires its workers, other firms might lose demand from the lay-offs and respond by firing their own workers leading to a recession at a new equilibrium. Coordination failure can also be associated with sunspot equilibria
(where equilibria are the result of variables that do not have any real impact on fundamentals) and animal spirits
.
Coordination failure can lead to an underemployment equilibrium
. Coordination failure also implies that fiscal policy
can move the economy to a higher-output equilibrium.
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
, coordination failure occurs when a group of firms could achieve a more desirable equilibrium but fail to because they do not coordinate their decision making. Coordination failure can result in a self-fulfilling prophecy
Self-fulfilling prophecy
A self-fulfilling prophecy is a prediction that directly or indirectly causes itself to become true, by the very terms of the prophecy itself, due to positive feedback between belief and behavior. Although examples of such prophecies can be found in literature as far back as ancient Greece and...
. For example, if one firm decides a recession is eminent and fires its workers, other firms might lose demand from the lay-offs and respond by firing their own workers leading to a recession at a new equilibrium. Coordination failure can also be associated with sunspot equilibria
Sunspots (economics)
In economics, the term sunspots usually refers to an extrinsic random variable, that is, a random variable that does not directly affect economic fundamentals...
(where equilibria are the result of variables that do not have any real impact on fundamentals) and animal spirits
Animal spirits
Animal spirits may refer to:*Animal spirits , the Keynesian term indicating the emotional component of economies represented in consumer confidence...
.
Coordination failure can lead to an underemployment equilibrium
Underemployment equilibrium
In Keynesian economics, underemployment equilibrium refers to a situation with a persistent shortfall relative to full employment and potential output so that unemployment is higher than at the NAIRU or the "natural" rate of unemployment. This situation is not seen as solvable via laissez-faire...
. Coordination failure also implies that fiscal policy
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
can move the economy to a higher-output equilibrium.
Works Cited
- Cooper, Russel and Andrew John. "Coordinating Coordination Failures." in New Keynesian Economics. eds. Mankiw, N. Gregory and Romer, David. MIT Press. Cambridge, Massachusetts: 1991.
- N. Gregory Mankiw, "New Keynesian Economics." The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. 7 October 2010.
- Mankiw, N. Gregory and Romer, David eds. New Keynesian Economics. MIT Press. Cambridge, Massachusetts: 1991.