Net Worth

Chapter 5 focuses on producers’ net worth. It joins a large strand rooted in the financial literature, which points out that under asymmetric information, producers need own equity to obtain credit. Incorporating this assumption yields scenarios with endogenous borrowing limits and shows that small variations in credit requirements have large macroeconomic consequences. A second theme concerns an unresolved problem of general equilibrium models. These determine equilibrium prices from decisions of producers and consumers who are ostensibly aware only of market prices and their own characteristics, i.e., technologies and preferences. However, consumers must also know current profits because these enter their budget constraints. As profits are determined in equilibrium, a logical circle emerges. Stock manias can be interpreted as situations where consumers overestimate profits; conversely, stock market crashes may reflect underestimations of profits. The text shows that misguided profit expectations as such do not have the expected impacts on economic activity.