Price-Output Dynamics and Returns to Scale

Heal, G. (1983). Price-Output Dynamics and Returns to Scale. IIASA Collaborative Paper. IIASA, Laxenburg, Austria: CP-83-043

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Abstract

I consider the dynamics of an economy where prices move in response to excess demand, and outputs change according to the difference between price and cost. If there are economies of scale in production, these adjustment processes lead the economy to one of two regimes. In one regime, output, productivity, and profits all rise, while prices fall. In the other, output, productivity, and profits all fall, while prices rise. Depending on initial conditions which are policy-amenable, the economy moves to self-reinforcing growth, or to stagflation. An exogenous shock, such as a rise in the price of an imported input or a sharp restriction of demand, may transfer a previously healthy economy from the growth-with-price-stability regime to the stagflationary regime.

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