We begin the study of economic environments underlying coordination games by considering the most direct form of interaction across agents: through a production function. As we shall see, this simple structure forms the basis for new insights into both aggregate economic fluctuations and growth. Further, this source of complementarity is most tractable in terms of quantitative analysis since it is most easily incorporated into the stochastic growth model.

Consequently, the discussion in this chapter contains both theory and quantitative evidence associated with the behavior of these economies. This focus reflects, in fact, recent developments in quantitative analysis which allow us to go beyond the stochastic growth model studied by Kydland and Prescott [1982] and King, Plosser and Rebelo [1988] to understand macroeconomic dynamics of economies with distortions.

INPUT GAMES AND TECHNOLOGICAL COMPLEMENTARITY

Assume that I agents provide effort into a joint production process. The per capita output of this process is f(e1, e2, …, eI) where ei is the effort level of agent i in the production process. We assume that e ∈ [0, 1] so that the strategy space is a complete lattice. Per capita output is also the consumption for each agent. Implicit here is an assumption about the nature of the compensation scheme: agents share equally in the output from their joint production.

Let U(Ci) be the utility from goods consumption and g(ei) be the disutility of effort for agent i. Hence

σ(ei, e) = U(f(e1, e2, …, eI)) – g(ei) (1)

Assume that U(-) is strictly increasing and concave and that g(-) is strictly increasing and strictly convex.