Monopolistic Competition when Income Matters

Authors


  • The authors are grateful to the Editor Martin Cripps, Daron Acemoglu, Simon Anderson, Paolo Epifani, Gene Grossman, Atsushi Kajii, James Markusen, Volker Nocke, Patrick Rey, Yossi Spiegel, Jacques Thisse, Kresimir Zigic and many anonymous referees. Seminar participants at the 2013 Cresse Conference in Corfu, the HSE Center for Market Studies and Spatial Economics in St. Petersburg, the University of Pavia, Ca’ Foscari University, Kyoto University, Hitotsubashi University and Yonsei University (Seoul) provided insightful comments.

Abstract

We analyse monopolistic competition when consumers have an indirect utility that is additively separable. This leads to markups depending on income (both in the short and long run) but not on the market size, which generates pricing to market, incomplete pass-through and pure gains from variety for countries that open up to trade. Firms’ heterogeneity à la Melitz implies a Darwinian effect of consumers’ spending on business creation and a Linderian effect on (endogenous) quality provision. We discuss extensions with an outside good and heterogenous agents, and offer simple and tractable specifications (linear or log-linear) of the demand functions.

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