Cost reduction, entry, and the interdependence of market structure and economic growth

I study the joint determination of market structure and growth in an oligopolistic economy. Firms run in-house R&D programs to produce over time a continuous flow of cost-reducing innovations. In symmetric equilibrium, the relation between market structure and growth has two aspects. First, a larger number of firms induces fragmentation of the market and dispersion of R&D resources. This prevents exploitation of scale economies internal to the firm and slows down growth. Second, the number of firms changes with market and technology conditions and is endogenous. In particular, R&D spending is a fixed cost and there is a negative feed-back of the rate of growth on the number of firms. The explicit consideration of the interdependence of market structure and growth identifies a fundamental trade-off between growth and variety that produces interesting results. For example, the scale effect is bounded from above and converges to zero when the number of firms is large. Moreover, the market grows too little and supplies too much variety. The inefficiency is not due to technological externalities but to oligopolistic pricing and the interaction between R&D and entry decisions.

Duke Scholars

Author Pietro F. Peretto Economics