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Income inequality and endogenous market structure under directed search

Serene Tan

Journal of Economic Theory, 2022, vol. 201, issue C

Abstract: This paper proposes a theory endogenizing the market structure when buyers' incomes are heterogeneous. Using a directed search model, ex ante identical firms choose the product quality of a good to sell and the target audience it wants to sell to, knowing only the income distribution of buyers. I show how the income distribution of buyers matters in determining the market structure. Segmentation of the product market by buyer income type can be obtained as an equilibrium phenomenon, but need not be. Firms respond to changes in income inequality by potentially changing not just prices, but also the qualities offered for sale. Firms' markups depend on income inequality, and worsening income inequality may manifest in higher markups, which are not due to changes in market power. Due to the endogeneity of the market structure, this paper makes explicit how changes in income inequality matter for agents' welfare.

Keywords: Income inequality; Endogenous market structure; Firm quality choice; Segmentation of markets; Directed search; Markups (search for similar items in EconPapers)
JEL-codes: D40 E23 E30 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.jet.2022.105423

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