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

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  • Bertoletti, Paolo
  • Fumagalli, Eileen
  • Poletti, Clara

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.

Suggested Citation

  • Bertoletti, Paolo & Fumagalli, Eileen & Poletti, Clara, 2017. "Price-cost margins and firm size under monopolistic competition: The case of IES preferences," Research in Economics, Elsevier, vol. 71(4), pages 653-662.
  • Handle: RePEc:eee:reecon:v:71:y:2017:i:4:p:653-662
    DOI: 10.1016/j.rie.2017.08.001
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    Cited by:

    1. Shon M. Ferguson, 2015. "Endogenous Product Differentiation, Market Size and Prices," Review of International Economics, Wiley Blackwell, vol. 23(1), pages 45-61, February.
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    3. Cavallari, Lilia & Etro, Federico, 2020. "Demand, markups and the business cycle," European Economic Review, Elsevier, vol. 127(C).
    4. Bykadorov, Igor & Kokovin, Sergey, 2017. "Can a larger market foster R&D under monopolistic competition with variable mark-ups?," Research in Economics, Elsevier, vol. 71(4), pages 663-674.
    5. Bertoletti, Paolo, 2018. "A note on Ramsey pricing and the structure of preferences," Journal of Mathematical Economics, Elsevier, vol. 76(C), pages 45-51.

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