An Equilibrium Model with Computationally Constrained Agents

TL;DR

This paper introduces a model of a large economy where firms' computational limitations in approximating equilibrium prices lead to multiple, inefficient equilibria and can cause counterintuitive effects of policy interventions on output.

Contribution

It develops a novel equilibrium model incorporating endogenous computational constraints of firms, revealing how these frictions generate multiple equilibria and affect macroeconomic outcomes.

Findings

Multiple equilibria arise due to computational constraints.

Policy changes can reduce output by impairing firms' price approximation.

Computational frictions can lead to inefficient low-output equilibria.

Abstract

We study a large economy in which firms cannot compute exact solutions to the non-linear equations that characterize the equilibrium price at which they can sell future output. Instead, firms use polynomial expansions to approximate prices. The precision with which they can compute prices is endogenous and depends on the overall level of supply. At the same time, firms' individual supplies, and thus aggregate supply, depend on the precision with which they approximate prices. This interrelation between supply and price forecast induces multiple equilibria, with inefficiently low output, in economies that otherwise have a unique, efficient equilibrium. Moreover, exogenous parameter changes, which would increase output were there no computational frictions, can diminish agents' ability to approximate future prices, and reduce output. Our model therefore accommodates the intuition that interventions, such as unprecedented quantitative easing, can put agents into "uncharted territory".