Monopolistic Competition, Increasing Returns to Scale, and the Welfare Costs of Inflation

32 Pages Posted: 25 Mar 1998

See all articles by Junxi Zhang

Junxi Zhang

The University of Hong Kong - School of Economics and Finance; National University of Singapore (NUS) - Department of Economics

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics

Date Written: January 1998

Abstract

This paper introduces monopolistic competition and increasing returns to scale into a monetary real business cycle (RBC) model to re-estimate the welfare costs of inflation. We first calibrate the model and show that it is capable of generating the observed aggregate fluctuations even when there are no shocks to the fundamentals. In particular, we demonstrate that this model matches the stylized U.S. business cycles facts as well as two more standard models. Then, we find that in this model the scale parameters and the intensity of competition significantly affect the welfare cost of inflation. Specifically, the cost is considerably higher than that in a standard RBC model with competitive markets and constant returns. Moreover, the stronger the increasing returns and the less intense the competition, the higher the welfare cost. These results are confirmed in a number of model specifications.

JEL Classification: E31, E32, E37

Suggested Citation

Zhang, Junxi Jack and Wu, Yangru, Monopolistic Competition, Increasing Returns to Scale, and the Welfare Costs of Inflation (January 1998). Available at SSRN: https://ssrn.com/abstract=70469 or http://dx.doi.org/10.2139/ssrn.70469

Junxi Jack Zhang

The University of Hong Kong - School of Economics and Finance ( email )

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National University of Singapore (NUS) - Department of Economics ( email )

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Singapore 119260
Republic of Singapore

Yangru Wu (Contact Author)

Rutgers University, Newark - School of Business - Department of Finance & Economics ( email )

1 Washington Park
Newark, NJ 07102
United States
973-353-1146 (Phone)
973-353-1006 (Fax)

HOME PAGE: http://andromeda.rutgers.edu/~yangruwu

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