Laurence Ball, N. Gregory Mankiw, and David romer depends on real aggregate demand as well as the real wage, because changes in aggregate demand shift the firms product demand (see - Real wages need not be countercyclical Imperfect competition can remedy an embarrassing empirical failure of traditional models based on sticky nominal wages--the cyclical behavior of real wages. We can tautologically write P= uW/MPL, where P is the price level, w is the wage, MPL is the marginal product of labor, and u is the markup of pric over marginal cost. If the markup is constant and marginal product of labor is diminishing, as many 1970s models assumed, then the real wage, W/P= MPL/u, must be countercyclical In actual economies, however, real wages appear acyclical or a bit procyclical. This fact can be explained if the marginal product of labor is constant, as suggested by Hall, or if the markup is countercyclical, as suggested by rotemberg and saloner and by Bils. 7 Thus there need not be a link between changes in employment and changes in real wages Nominal rigidities have aggregate demand externalities. As we explained, since real aggregate demand affects the demand curve facing individual firms, nominal rigidities have externalities. Rigidity in one firms price contributes to rigidity in the price level, which causes fluctuations in real aggregate demand and thus harms all firms. These externalities are crucial to the finding that small frictions can have large macroeconomic effects. The externalities depend on imperfect compe tition, for under perfect competition, aggregate demand is irrelevant to individual firms because they can sell all they want at the going price Product Market rigidi nd most Keyne rigidities in nominal wages. But recent work focuses largely on rigidities in product prices. The change offers two advantages -Goods are sold in spot markets. Although there is clearly much wage rigidity in actual economies-in U.S. labor contrac example, wages are set up to three years in advance-the allocative effects of this rigidity are unclear. The implicit contracts literature shows that it may be efficient for contract signers to make employment 17, Robert E, Hall, * Market Structure and Macroeconomic Fluctuations, BPEA 2: 1986, pp. 285-322; Julio J. Rotemberg and Garth Saloner, "A Supergame-Theoretic Model of Price Wars during Booms, American Economic Review, vol 76 ( June 1986) pp. 390-407: Mark Bils, *Cyclical Pricing of Durable Luxuries, Working Paper 83 ( University of Rochester Center for Economic Research, May 198