Working Paper: NBER ID: w14383
Authors: Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
Abstract: The inefficiencies related to endogenous product creation and variety under monopolistic competition are two-fold: one static—the misalignment between consumers and producers regarding the value of a new variety; and one dynamic—time variation in markups. Quantitatively, the welfare costs of the former are potentially very large relative to the latter. For a calibrated version of our model with these distortions, their total cost amounts to 2 percent of consumption. Appropriate taxation schemes can implement the optimum amount of entry and variety. Elastic labor introduces a further distortion that should be corrected by subsidizing labor at a rate equal to the markup for goods, in order to preserve profit margins and hence entry incentives.
Keywords: monopoly power; endogenous product variety; welfare costs; fiscal policies
JEL Codes: D42; H32; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monopoly power (D42) | inefficiencies in the economy (D61) |
| static distortion (H31) | excessive entry of firms (L11) |
| dynamic distortion (C69) | inefficiencies in resource allocation (D61) |
| monopoly power (D42) | static distortion (H31) |
| monopoly power (D42) | dynamic distortion (C69) |
| static distortion (H31) | welfare costs (I30) |
| dynamic distortion (C69) | welfare costs (I30) |
| fiscal policies (H30) | restore efficiency (D61) |
| monopoly profits (D42) | optimal level of product variety (L15) |
| competitive equilibria (D50) | welfare implications of distortions (D69) |
| planner equilibria (D51) | welfare implications of distortions (D69) |