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On financial frictions and firm market power

Author

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  • M. Casares
  • LG Deidda
  • J. E. Galdon-Sanchez

Abstract

We build a static general-equilibrium model with monopolistically competitive firms that borrow funds from competitive banks in an economy subject to financial frictions. These frictions are due to non verifiability of both ex post firm returns and managerial effort. Market power has opposing effects. On one side, firms' pricing over marginal cost reduces output compared to perfect competition. On the other, by increasing firms' profitability, market power reduces the impact of financial frictions. The resulting tradeoff is ambiguous. We show that, other things equal, there exists an optimal positive level of market power that maximizes welfare. Such optimal degree of market power increases with moral hazard and decreases with the efficiency of firm liquidation following bankruptcy.

Suggested Citation

  • M. Casares & LG Deidda & J. E. Galdon-Sanchez, 2019. "On financial frictions and firm market power," Working Paper CRENoS 201913, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
    • Handle: RePEc:cns:cnscwp:201913
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    More about this item

    Keywords

    moral hazard; Market power; liquidation; bankurptcy;
    All these keywords.

    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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