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Extended linear-homothetic preferences and the Cournot-Bertrand profit differential

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  • Correa López, Mónica

Abstract

This paper introduces the ‘extended linear-homothetic’ preferences to model consumer choice. Specifically, we extend Datta and Dixon’s (2000) ‘standard linear-homothetic’ preferences by adding an additional term to the unit cost function. This term captures the relative importance of price interactions within sectors on the unit cost of utility. In an economy composed of a large number of sectors (K) with a sufficiently large number of firms (n) in each, the ‘extended linear-homothetic’ preferences yield (perceived) linear demands in own strategy and competitors’ strategies - where goods are characterized as substitutes. Thus, the linearity and homotheticity properties of the preferences open the possibility to develop a tractable model of oligopoly in general equilibrium. An additional novelty introduced by the ‘extended linear-homothetic’ preferences is the presence of a sectoral-specific price index in product demand. For n small, this implies that firms internalize the sectoral price effects of their individual pricing strategies. The latter, we argue, may provide us with a link between nonatomistic price and wage setters and the monetary authority.

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  • Correa López, Mónica, 2003. "Extended linear-homothetic preferences and the Cournot-Bertrand profit differential," Economics Discussion Papers 8868, University of Essex, Department of Economics.
    • Handle: RePEc:esx:essedp:8868
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    References listed on IDEAS

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    1. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    2. David Soskice & Torben Iversen, 2000. "The Nonneutrality of Monetary Policy with Large Price or Wage Setters," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(1), pages 265-284.
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    4. Bipasa Datta & Huw Dixon, 2001. "ω‐Homothetic Preferences: Theory and Applications," Scottish Journal of Political Economy, Scottish Economic Society, vol. 48(2), pages 148-163, May.
    5. Datta, Bipasa & Dixon, Huw, 2000. "Linear-homothetic preferences," Economics Letters, Elsevier, vol. 69(1), pages 55-61, October.
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