Price-Increasing Monopolistic Competition? The Case of IES Preferences
IEFE Working Paper No. 15
18 Pages Posted: 19 Nov 2008 Last revised: 23 Nov 2008
Date Written: October 1, 2008
Abstract
We introduce a new class of "increasing elasticity of substitution" (IES) preferences to model product differentiation. In a monopolistic competition setting a la Dixit - Stiglitz (1977) we find that, even under constant returns to scale and complete information, a rise in the number of firms can be price-increasing. This result extends to Cournotian competition. Despite the price increase, consumers benefit from a rise in the number of monopolistic competitors because of higher product diversity. Higher prices are therefore associated with higher consumer welfare. Our results suggest a possible explanation to the empirical puzzle posed by the countercyclical movements of price-cost margins following globalisation and market reforms. In addition, they should be of interest for real business cycle literature which investigates the impact of an endogenous market structure.
Keywords: monopolistic competition, endogenous mark up, elasticity of substitution
JEL Classification: D43, D11, L11, L16
Suggested Citation: Suggested Citation