Cost Reduction, Entry, and the Dynamics 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 (incremental) innovations. In symmetric equilibrium, the dispersion of resources across firms prevents the exploitation of scale economies in R&D and slows down growth. In free-entry equilibrium, the number of firms changes with market and technological conditions and is endogenous. In particular, R&D spending is a (fixed) sunk 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 produces novel results. The comparative statics effects of many parameters are no longer those predicted by conventional wisdom. For example, I find negative effects of population size and R&D productivity on growth. The key to these results is a fundamental trade-off between growth and variety, between the rate of growth of consumption of each product and the number of products. Firms do not internalize this trade-off and the market grows faster and supplies less variety than is optimal. Taxes and subsidies bring Pareto efficiency