Laurence Ball, N. Gregory Mankiw, and David Romer THE NEW ASSUMPTIONS IN NEW KEYNESIAN MODELS Aside from the specific arguments outlined above, recent research establishes the general point that nominal rigidities can result from optimizing choices of agents in well-specified models. This contrasts with the ad hoc imposition of rigidities in many of the Keynesian models of the 1970s. Recent progress is largely a result of two innovations in modeling: the introduction of imperfect competition and greater empha sis on price rather than wage rigidities Imperfect Competition. Microeconomists have long recognized that sticky prices and perfect competition are incompatible. 4 Inacompetitive market, a firm does not set its price, but accepts the price quoted by the alrasian auctioneer. Only under imperfect competition, when firms set prices, does it make sense to ask whether a firm adjusts its price to a shock. Nonetheless, Keynesian models of the 1970s, most clearly disequilibrium models, imposed nominal rigidities on otherwise Walras ian economies. The result was embarrassments in the form of unappeal ing results or the need for additional arbitrary assumptions. Many recent models simply generalize earlier models by allowing the firms'demand curves to slope down. This single modification sweeps away many of the problems with older models. Specifically, the new models with imperfect competition offer six advantages tion, the gains from nominal adjustment are large. For example, if nominal demand rises and prices do not adjust, there is excess demand In this situation, an individual firm can raise its price significantly and still sell as much output as before, which implies a large increase in profits. In contrast, under imperfect competition a higher price always implies lower sales. Starting from the profit-maximizing price-q antity ombination, the gains from trading off price and sales after a shock are second order Anticipated Inflation, and Output, Quarterly Journal of Economics, vol. 101(May 1986 Honor of Bernard Francis Haley(Stanford University Press, 1959), pp 41-. 'Essm ,in 14. See, for example, Kenneth J, Arrow, Toward a Theory of Price Adjustment, Moses Abramovitz and others, eds, The Allocation of Economic Resources