Staff Report 312

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Non-Convexities in Quantitative General Equilibrium Studies of Business Cycles

Edward C. Prescott - Senior Monetary Advisor

Revised November 1, 2003

Abstract
This paper reviews the role of micro non-convexities in the study of business cycles. One important non-convexity arises because an individual can work only one workweek length in a given week. The implication of this non-convexity is that the aggregate intertemporal elasticity of labor supply is large and the principal margin of adjustment is in the number employed—not in the hours per person employed—as observed. The paper also reviews a business cycle model with an occasionally binding capacity constraint. This model better mimics business cycle fluctuations than the standard real business cycle model. Aggregation in the presence of micro non-convexities is key in the model.


Published In: Frontiers in Applied General Equilibrium Modeling: In Honor of Herbert Scarf (2005, pp. 95-118)

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