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On financial frictions and firm's market power

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  • Miguel Casares
  • Luca G. Deidda
  • Jose E. Galdon‐Sanchez

Abstract

There are two opposing welfare effects of market power in a model with monopolistic competition, loan defaults and moral hazard. The loss of output produced if firms set a higher mark‐up over marginal costs confronts with some gain due to higher expected profits and the reduction of defaults. Such tradeoff results in an optimal level of market power that decreases with the efficiency of liquidation following default on a loan. If moral hazard is pervasive, credit rationing cuts down the default rates and mitigates the welfare cost of financial frictions.

Suggested Citation

  • Miguel Casares & Luca G. Deidda & Jose E. Galdon‐Sanchez, 2023. "On financial frictions and firm's market power," Economic Inquiry, Western Economic Association International, vol. 61(4), pages 982-1005, October.
    • Handle: RePEc:bla:ecinqu:v:61:y:2023:i:4:p:982-1005
    DOI: 10.1111/ecin.13146
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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