International Journal of Business and Economics Volume 8, No. 2 August, 2009

Why Is a Financial Crisis Important? The Significance of the Relaxation of the Assumption of Perfect Competition

Yew-Kwang Ng

Department of Economics, Monash University, Australia

Abstract

Under the usual assumption of perfect competition, we have money being neutral and changes in nominal aggregate demand cannot affect the real economic variables. If so, a financial crisis cannot be very important. However, the real world is characterized more by non-perfect competition when changes in nominal demand can affect real variables. This paper shows the important differences and explains the crux of these differences from both the demand and cost sides. It also provides a simplified general-equilibrium analysis of the economy and shows that, by concentrating on a representative firm and on how this firm is affected by macro variables and simplified interaction with other firms, macro analysis of the economy without assuming perfect competition is manageable with more realistic and richer results.

Keywords：competition, financial crisis, market power, money neutrality, recession.

JEL Classifications：D40, E10, E30.

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