Bigger is Better: Market Size, Demand Elasticity, and Innovation

15 Pages Posted: 26 May 2010

See all articles by Klaus Desmet

Klaus Desmet

Southern Methodist University (SMU); Centre for Economic Policy Research (CEPR)

Stephen L. Parente

University of Illinois at Urbana-Champaign - Department of Economics

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.

Suggested Citation

Desmet, Klaus and Parente, Stephen L., Bigger is Better: Market Size, Demand Elasticity, and Innovation. International Economic Review, Vol. 51, Issue 2, pp. 319-333, May 2010. Available at SSRN: https://ssrn.com/abstract=1611950 or http://dx.doi.org/10.1111/j.1468-2354.2010.00581.x

Klaus Desmet (Contact Author)

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Stephen L. Parente

University of Illinois at Urbana-Champaign - Department of Economics ( email )

410 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States

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