Darwinian Returns to Scale

David Baqaee and Emmanuel Farhi

No 15712, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: How does an increase in the size of the market, say due to fertility, immigration, or globalization, affect welfare? We study this question using a model with heterogeneous firms, Kimball preferences, fixed costs, and monopolistic competition. We decompose changes in welfare from increased scale into changes in technical efficiency and changes in allocative efficiency due to reallocation. We non-parametrically identify residual demand curves with firm-level data from Belgian manufacturing firms and, using these estimates, quantify our theoretical results. We find that around 80% of the aggregate returns to scale are due to changes in allocative efficiency. As markets get bigger, competition intensifies and triggers Darwinian reallocations: socially-valuable firms expand, small firms shrink and exit, and new firms enter. However, important as they are, improvements in allocative efficiency are not driven by reductions in markups or deaths of unproductive firms. Instead, they are caused by a composition effect that reallocates resources from low- to high-markup firms.

Keywords: Increasing returns; Allocative efficiency; Incomplete pass-through; Monopolistic competition; Market size effect (search for similar items in EconPapers)
JEL-codes: E0 L1 O4 (search for similar items in EconPapers)
Date: 2021-01
New Economics Papers: this item is included in nep-bec, nep-com and nep-mac
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: The Darwinian Returns to Scale (2024)
Working Paper: The Darwinian Returns to Scale (2020)
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