page_title: History of macroeconomic thought
section_title: Coordination failure
hierarchical_section_title: History of macroeconomic thought / New Keynesian economics / Coordination failure
context_page_description: Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
  The generation of economists that followed Keynes synthesized his theory with neoclassical microeconomics to form the neoclassical synthesis. Although Keynesian theory originally omitted an explanation of price levels and inflation, later Keynesians adopted the Phillips curve to model price-level changes. Some Keynesians opposed the synthesis method of combining Keynes's theory with an equilibrium system and advocated disequilibrium models instead.
context_section_description: Coordination failure is another potential explanation for recessions and unemployment. In recessions a factory can go idle even though there are people willing to work in it, and people willing to buy its production if they had jobs. In such a scenario, economic downturns appear to be the result of coordination failure: The invisible hand fails to coordinate the usual, optimal, flow of production and consumption. Russell Cooper and Andrew John (1988) expressed a general form of coordination as models with multiple equilibria where agents could coordinate to improve (or at least not harm) each of their respective situations. Cooper and John based their work on earlier models including Peter Diamond's (1982) coconut model, which demonstrated a case of coordination failure involving search and matching theory. In Diamond's model producers are more likely to produce if they see others producing. The increase in possible trading partners increases the likelihood of a given producer finding someone to trade with. As in other cases of coordination failure, Diamond's model has multiple equilibria, and the welfare of one agent is dependent on the decisions of others. Diamond's model is an example of a "thick-market externality" that causes markets to function better when more people and firms participate in them. Other potential sources of coordination failure include self-fulfilling prophecies. If a firm anticipates a fall in demand, they might cut back on hiring. A lack of job vacancies might worry workers who then cut back on their consumption. This fall in demand meets the firm's expectations, but it is entirely due to the firm's own actions.
caption: In this model of coordination failure, a representative firm ei makes its output decisions based on the average output of all firms (ē). When the representative firm produces as much as the average firm (ei=ē), the economy is at an equilibrium represented by the 45-degree line. The decision curve intersects with the equilibrium line at three equilibrium points. The firms could coordinate and produce at the optimal level of point B, but, without coordination, firms might produce at a less efficient equilibrium.[148][149]