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In
economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...
, coordination failure is a concept that can explain
recessions In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
through the failure of firms and other price setters to coordinate. In an economic system with multiple equilibria, coordination failure occurs when a group of firms could achieve a more desirable equilibrium but fail to because they do not coordinate their decision making. Coordination failure can result in a self-fulfilling prophecy.Romer, 305. For example, if one firm decides a recession is imminent and fires its workers, other firms might lose demand from the lay-offs and respond by firing their own workers leading to a recession at a new equilibrium. Coordination failure can also be associated with sunspot equilibria (where equilibria are the result of variables that do not have any real impact on fundamentals) and animal spirits. Coordination failure can lead to an underemployment equilibrium. Coordination failure also implies that
fiscal policy In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
can mitigate the effects of recessions, or even avoid them entirely, by moving the economy to a higher-output equilibrium. In game theory, coordination failure can also be analyzed by
focal point (game theory) In game theory, a focal point (or Schelling point) is a solution that people tend to choose by default in the absence of communication. The concept was introduced by the American economist Thomas Schelling in his book ''The Strategy of Conflict'' ( ...
. Focal points are solutions that players choose by default without the presence of communication. For example, players in a
coordination game A coordination game is a type of simultaneous game found in game theory. It describes the situation where a player will earn a higher payoff when they select the same course of action as another player. The game is not one of pure conflict, which r ...
are unable to cooperate to reach mutual optimal solution without observing other players' choices and hence will only choose their best choices according to available information on hand. This will lead to a solution where players in the game gain lower payoffs than in the case of successful cooperation, and result in a coordination failure issue.


Example

Models of coordination failure can have multiple equilibria. In this example a representative firm ei makes its output decisions based on the average output of other firms (e*). When the representative firm produces as much as the average firm (ei=e*), the economy is at an equilibrium. The curve represents possible output decisions for the individual firm, and it intersects with the 45 degree line at three points, meaning there are three equilibria. If the firm and society are better off with more output, point B is most desirable. However, the firm's production is determined by what the other firms decide. Ideally, they could all coordinate to produce at the level corresponding with the equilibrium at point B, but, if they fail to coordinate, firms might produce at a less efficient equilibrium. In the workplace Jordi Brandts and David J. Cooper study how to overcome coordination failure in a corporate organization, where this issue arises between manager and employees. In this study, they discuss that a manager can prevent the coordination failure issue by either increasing financial incentives for his employees or communicating with the employees. They also find that the communication tool, especially clear and direct communication, is more effective than the incentive tool if the manager wants to overcome coordination failure and hence improve the employees’ performance. Brandts and Cooper (2007), 1223-1268.


See also

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Diamond coconut model The Diamond coconut model is an economic model constructed by the American economist and 2010 Nobel laureate Peter Diamond which analyzes how a search economy in which traders cannot find partners instantaneously operates. The model was first pr ...
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Coordination game A coordination game is a type of simultaneous game found in game theory. It describes the situation where a player will earn a higher payoff when they select the same course of action as another player. The game is not one of pure conflict, which r ...
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Strategic complementarity In economics and game theory, the decisions of two or more players are called strategic complements if they mutually reinforce one another, and they are called strategic substitutes if they mutually offset one another. These terms were originally ...
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Focal point (game theory) In game theory, a focal point (or Schelling point) is a solution that people tend to choose by default in the absence of communication. The concept was introduced by the American economist Thomas Schelling in his book ''The Strategy of Conflict'' ( ...


Notes


References

* * Cooper, Russel and Andrew John. "Coordinating Coordination Failures." in ''New Keynesian Economics''. eds. Mankiw, N. Gregory and Romer, David. MIT Press. Cambridge, Massachusetts: 1991. * * * Mankiw, N. Gregory and Romer, David eds. ''New Keynesian Economics''. MIT Press. Cambridge, Massachusetts: 1991. {{DEFAULTSORT:Coordination Failure (Economics) New Keynesian economics Fiscal policy