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Bigger Is Better: Market Size, Demand Elasticity, And Innovation

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  • Klaus Desmet
  • Stephen L. Parente

Abstract

This article proposes a novel mechanism whereby larger markets increase competition and facilitate process innovation. Larger markets, in the sense of more people or more open trade, support a larger variety of goods, resulting in a more crowded product space. This raises the price elasticity of demand and lowers markups. Firms, therefore, become larger to break even. This facilitates process innovation, as larger firms can amortize R&D costs over more goods. We demonstrate this mechanism in a standard model of process and product innovation. In doing so, we question some important results in the new trade and endogenous growth literatures. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Klaus Desmet & Stephen L. Parente, 2010. "Bigger Is Better: Market Size, Demand Elasticity, And Innovation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(2), pages 319-333, May.
  • Handle: RePEc:ier:iecrev:v:51:y:2010:i:2:p:319-333
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    Cited by:

    1. Azman-saini, W.N.W & Tun, Yin-Li & Ibhrahim, Saifuzzaman, 2013. "International evidence on the link between foreign direct investment and economic freedom," MPRA Paper 65894, University Library of Munich, Germany.
    2. Klaus Desmet & Stephen Parente, 2012. "The evolution of markets and the revolution of industry: a unified theory of growth," Journal of Economic Growth, Springer, vol. 17(3), pages 205-234, September.
    3. Hélène Latzer & Florian Mayneris, 2011. "Trade in quality and income distribution: an analysis of the enlarged EU market," Working Papers of BETA 2011-21, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    4. Klaus Desmet & Stephen Parente, 2014. "Resistance to Technology Adoption: The Rise and Decline of Guilds," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 437-458, July.
    5. Desmet, Klaus & Greif, Avner & Parente, Stephen L., 2017. "Spatial Competition, Innovation and Institutions: The Industrial Revolution and the Great Divergence," CEPR Discussion Papers 11976, C.E.P.R. Discussion Papers.
    6. Michele Battisti & Massimo Del Gatto & Christopher F. Parmeter, 2018. "Labor productivity growth: disentangling technology and capital accumulation," Journal of Economic Growth, Springer, vol. 23(1), pages 111-143, March.
    7. Chiara Criscuolo & Peter N. Gal & Carlo Menon, 2014. "The Dynamics of Employment Growth: New Evidence from 18 Countries," CEP Discussion Papers dp1274, Centre for Economic Performance, LSE.
    8. repec:bla:ecinqu:v:55:y:2017:i:2:p:794-805 is not listed on IDEAS
    9. Michele Battisti & Filippo Belloc & Massimo Del Gatto, 2015. "Unbundling Technology Adoption and tfp at the Firm Level: Do Intangibles Matter?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 24(2), pages 390-414, June.
    10. Massimiliano Bratti & Giulia Felice, 2012. "Are Exporters More Likely to Introduce Product Innovations?," The World Economy, Wiley Blackwell, vol. 35(11), pages 1559-1598, November.
    11. Claudio Fassio, 2018. "Export-led innovation: the role of export destinations," Industrial and Corporate Change, Oxford University Press, vol. 27(1), pages 149-171.
    12. Choi, Chi-Young & Choi, Horag, 2016. "The role of two frictions in geographic price dispersion: When market friction meets nominal rigidity," Journal of International Money and Finance, Elsevier, vol. 63(C), pages 1-27.
    13. Fassio, Claudio, 2015. "Export-Led Innovation Among European Firms. Demand and Technological Learning Effects," SEP Working Papers 2015/2, LUISS School of European Political Economy.
    14. Gonzalo F. Forgues-Puccio & Ibrahim M. Okumu, 2012. "Does Size Matter? Scale, Corruption and Uncertainty," CDMA Working Paper Series 201207, Centre for Dynamic Macroeconomic Analysis.
    15. Pedro Bento, 2015. "Quantifying the Effects of Patent Protection on Innovation, Imitation, Growth, and Aggregate Productivity," Working Papers 20150801-001, Texas A&M University, Department of Economics.
    16. Michele Battisti & Filippo Belloc & Massimo Del Gatto, 2017. "Technology-specific Production Functions," Working Paper series 17-26, Rimini Centre for Economic Analysis.
    17. Desmet, Klaus & Parente, Stephen, 2009. "The Evolution of Markets and the Revolution of Industry: A Quantitative Model of England's Development, 1300-2000," CEPR Discussion Papers 7290, C.E.P.R. Discussion Papers.
    18. Ferto, Imre & Bojnec, Stefan, 2015. "Quality upgrading in the European-Union agri-food exports," 89th Annual Conference, April 13-15, 2015, Warwick University, Coventry, UK 204225, Agricultural Economics Society.
    19. Lei Fang, 2017. "Entry Barriers, Competition, And Technology Adoption," Economic Inquiry, Western Economic Association International, vol. 55(2), pages 794-805, April.
    20. repec:eee:tefoso:v:122:y:2017:i:c:p:128-138 is not listed on IDEAS
    21. Huning, Thilo R. & Wolf, Nikolaus, 2016. "How England Unified Germany: Geography and the Rise of Prussia After 1815," Annual Conference 2016 (Augsburg): Demographic Change 145725, Verein für Socialpolitik / German Economic Association.
    22. Adelheid Holl & Rafael Pardo & Ruth Rama, 2013. "Spatial patterns of adoption of just-in-time manufacturing," Papers in Regional Science, Wiley Blackwell, vol. 92(1), pages 51-67, March.
    23. repec:eee:jeeman:v:83:y:2017:i:c:p:197-216 is not listed on IDEAS
    24. repec:bla:jageco:v:68:y:2017:i:1:p:269-279 is not listed on IDEAS
    25. Ciani, Andrea, 2017. "Income inequality and the quality of imports," DICE Discussion Papers 245, University of Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).

    More about this item

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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