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Price-cost margins and firm size under monopolistic competition: The case of IES preferences

Paolo Bertoletti (), Eileen Fumagalli and Clara Poletti

Research in Economics, 2017, vol. 71, issue 4, 653-662

Abstract: We introduce a class of “increasing elasticity of substitution” preferences in a monopolistic competition setting à la Dixit and Stiglitz (1977). Contrary to the standard view, we find that a market which is widening, as a result of, for example, international trade, increases price-cost margins and reduces firm sizes. However, even if prices are higher (with constant marginal costs), consumers benefit from the market expansion because of higher product diversity (the free-entry equilibrium has a sub-optimal number of varieties). Our results might contribute to explain the puzzle posed by the movements of markups following globalisation. They could also help explaining the cyclical behaviour of prices.

Keywords: Monopolistic competition; Endogenous markup; Firm size; Elasticity of substitution (search for similar items in EconPapers)
Date: 2017
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