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Markups and Agglomeration: Price Competition versus Externalities

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  • Liqiu Zhao
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    Abstract

    Agglomeration can affect markups through two potential channels: agglom- erated regions toughen competition (price competition effect) and firms are more productive on average in agglomerated regions (agglomeration exter- nalities and firm selection effect). However, the literature is inconclusive on which force dominates. This paper models these two channels by in- troducing agglomeration economies to the model of Melitz and Ottaviano (2008). Under parameters from the empirical studies, I demonstrate that the price competition effect tends to dominate the others, i.e., firms in more agglomerated regions charge lower markups. Using a unique Chinese firm- level data from 2002 to 2004, I investigate the effect of spatial agglomeration on markups of firms. By addressing the potential endogeneity problems us- ing instrumental-variable method, I find that in China an increase in the number of own-industry firms in the same region has a negative causal ef- fect on markups of firms and a positive effect on productivity. But firms in agglomerated regions have higher output and profit.

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    File URL: http://www.econ.kuleuven.be/VIVES/publicaties/discussionpapers/DP/DP2011/2011vivesdp22-markupsagglo-zhao.pdf
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    Bibliographic Info

    Paper provided by Katholieke Universiteit Leuven, Faculteit Economie en Bedrijfswetenschappen, Vives in its series Vives discussion paper series with number 22.

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    Date of creation: 2011
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    Handle: RePEc:ete:vivwps:22

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