Destabilizing Effects of Market Size in the Dynamics of Innovation

51 Pages Posted: 28 Jul 2020 Last revised: 4 Feb 2022

See all articles by Kiminori Matsuyama

Kiminori Matsuyama

Northwestern University - Department of Economics

Philip Ushchev

HSE Moscow

Date Written: July 2020

Abstract

In existing models of endogenous innovation cycles, market size alters the amplitude of fluctuations without changing the nature of fluctuations. This is due to the ubiquitous assumption of CES homothetic demand system, implying that monopolistically competitive firms sell their products at an exogenous markup rate in spite of the empirical evidence for the procompetitive effect of entry and market size. We extend the Judd model of endogenous innovation cycles to allow for the procompetitive effect, using a more general homothetic demand system. We show that a larger market size/innovation cost ratio, by reducing the markup rate through the procompetitive effect, has destabilizing effects on the dynamics of innovation under two complementary sets of sufficient conditions; i) when the price elasticity is "not too convex" in price; and ii) when the demand system belongs to the two parametric families, "generalized translog" and "constant pass-through," each of which features the choke price and yet contains CES as a limit case. Interestingly, the destabilizing effects become amplified as the demand system approaches to the CES limit within each family. We also discuss some cross-sectional implications in a multi-market extension. Because innovation/entry activities fluctuate more in larger markets, they are not always higher in larger markets than smaller markets. Furthermore, the sale of each product is more volatile in larger markets.

Keywords: Dynamic monopolistic competition, Endogenous innovation cycles, H.S.A., Market size and volatility, Periodic cycle, Piecewise-linear dynamical system, Procompetitive Effect, Robust chaotic attractor, the Judd model

JEL Classification: D43, E32, L13, O31

Suggested Citation

Matsuyama, Kiminori and Ushchev, Philip, Destabilizing Effects of Market Size in the Dynamics of Innovation (July 2020). CEPR Discussion Paper No. DP15010, Available at SSRN: https://ssrn.com/abstract=3650125

Kiminori Matsuyama (Contact Author)

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States
847-491-8490 (Phone)
847-491-7001 (Fax)

Philip Ushchev

HSE Moscow ( email )

26 Shabolovka
Moscow
Russia

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