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Will AI Intensify or Weaken Market Competition?

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Abstract

We study how AI affects market competition based on a general equilibrium framework with heterogeneous firms facing idiosyncratic productivity and variable markups. Firms choose the AI technology subject to fixed costs, where AI production requires data and energy inputs. Our model predicts a non-monotonic relation of AI diffusion with industry concentration. As AI usage rises from an initially low level, large incumbent users gain market share. When AI usage is sufficiently diffused, entry of new and smaller adopters erodes the market share of incumbents, reducing industry concentration. The non-monotonic relations are robust when firms can complement AI with their own data. Our calibrated model predicts that industry concentration is likely to fall if AI adoption increases relative to the current level. In comparison, the relation of AI with the average markup depends on whether increased AI usage is driven by demand or supply factors. Our model also predicts that a modest subsidy of about 3 percent for AI adopter revenues maximizes social welfare, reflecting a tradeoff between aggregate productivity and the average markup associated with AI usage.

Suggested Citation

  • Hamid Firooz & Sylvain Leduc & Zheng Liu, 2026. "Will AI Intensify or Weaken Market Competition?," Working Paper Series 2026-15, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:103630
    DOI: 10.24148/wp2026-15
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    References listed on IDEAS

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    1. Daron Acemoglu & David Autor & Jonathon Hazell & Pascual Restrepo, 2022. "Artificial Intelligence and Jobs: Evidence from Online Vacancies," Journal of Labor Economics, University of Chicago Press, vol. 40(S1), pages 293-340.
    2. Joshua S. Gans, 2023. "Artificial intelligence adoption in a competitive market," Economica, London School of Economics and Political Science, vol. 90(358), pages 690-705, April.
    3. Babina, Tania & Fedyk, Anastassia & He, Alex & Hodson, James, 2024. "Artificial intelligence, firm growth, and product innovation," Journal of Financial Economics, Elsevier, vol. 151(C).
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    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

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