DP14250 Reconsidering the Market Size Effect in Innovation and Growth

Author(s): Helene Latzer, Kiminori Matsuyama, Mathieu Parenti
Publication Date: December 2019
Keyword(s): balanced growth, Competition and growth, Demand composition, Directly explicitly additive (DEA) preferences, Endogenous Growth, Horizontal innovation, Incomplete pass-through, Nonhomothetic preferences, Procompetitive entry, Strategic complementarity in pricing
JEL(s): O11, O31, O33
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14250

In the standard horizontal innovation model of endogenous growth, larger economies innovate more and grow faster. Due to the homotheticity of preferences, however, it does not matter whether the large market size comes from a large population or a high per capita expenditure. In this paper, we extend the standard model to allow for nonhomothetic preferences. Among others, we show that, holding the size fixed, economies with higher per capita expenditure and smaller populations innovate more and grow faster for the empirically relevant case of incomplete pass-through, strategic complementarity in pricing, and procompetitive entry.