Product Diversity, Demand Structures, and Optimal Taxation

25 Pages Posted: 7 Feb 2015

See all articles by Vivien Lewis

Vivien Lewis

Research Centre; KU Leuven

Roland Winkler

Dortmund University, Faculty of Business, Economics, and Social Sciences,

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Date Written: April 2015

Abstract

This article studies optimal taxation in a general equilibrium macroeconomic model with endogenous entry. We compare the constant elasticity of substitution (CES) model to three alternative demand structures: oligopolistic competition in prices, oligopolistic competition in quantities, and translog preferences. Our economy is characterized by two distortions: a labor distortion due to the misalignment of markups on goods and leisure, and an entry distortion due to the misalignment of the consumer surplus effect and the profit destruction effect of entry. The two distortions interact in determining the wedge between the market-driven and optimal level of product diversity. We show how optimal labor and entry taxes depend on the prevailing demand structure, the nature and size of entry costs, and the degree of substitutability between goods.

JEL Classification: E22, E61, E62

Suggested Citation

Lewis, Vivien and Winkler, Roland, Product Diversity, Demand Structures, and Optimal Taxation (April 2015). Economic Inquiry, Vol. 53, Issue 2, pp. 979-1003, 2015. Available at SSRN: https://ssrn.com/abstract=2561665 or http://dx.doi.org/10.1111/ecin.12159

Vivien Lewis (Contact Author)

Research Centre ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

KU Leuven ( email )

Oude Markt 13
Leuven, 3000
Belgium

Roland Winkler

Dortmund University, Faculty of Business, Economics, and Social Sciences, ( email )

United States

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