Product Differentiation, Fiscal Policy, and Free Entry
Entry is recognized to be an important issue in macro models considering imperfectly competitive markets. However, two lines of research have been kept apart: the homogeneous-product oligopoly approach, where entry means more firms in the industry, and the monopolistic competition approach, where it means more brands. Our model tries to go beyond these limitations, considering a small open economy within a monetary union (characterised by a fixed exchange rate and perfect financial capital mobility). In this economy each industry produces a differentiated non-tradable good and is composed several Cournot competitors. Competition works at both the intraindustry and sector level. Decisions on both taxes and government expenditure are taken by the economy’s government, i.e., fiscal policy is decentralised within the monetary union. Since the model generates multiple equilibria, three types of entry are considered: more firms (I), more industries (II), and a combination of both (III). Fiscal policy is shown to be effective on aggregate output under the three cases. Its effect on welfare is mainly walrasian in case II, but it can be keynesian when market power is high in cases I or III.
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