Premium
BIGGER IS BETTER: MARKET SIZE, DEMAND ELASTICITY, AND INNOVATION *
Author(s) -
Desmet Klaus,
Parente Stephen L.
Publication year - 2010
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/j.1468-2354.2010.00581.x
Subject(s) - price elasticity of demand , economics , market size , industrial organization , product innovation , elasticity (physics) , microeconomics , competition (biology) , endogenous growth theory , product market , elasticity of substitution , commerce , market economy , production (economics) , ecology , materials science , incentive , composite material , biology , human capital
This article proposes a novel mechanism whereby larger markets increase competition and facilitate process innovation. Larger markets, in the sense of more people or more open trade, support a larger variety of goods, resulting in a more crowded product space. This raises the price elasticity of demand and lowers markups. Firms, therefore, become larger to break even. This facilitates process innovation, as larger firms can amortize R&D costs over more goods. We demonstrate this mechanism in a standard model of process and product innovation. In doing so, we question some important results in the new trade and endogenous growth literatures.