Paper by CMSSE leading research fellow Philip Ushchev accepted for publication to the Journal of Economic Geography.
Paper by CMSSE leading research fellow Philip Ushchev ""(joint with Alberto Bucci) accepted for publication to the Journal of Economic Geography.
Abstract. We develop a model of monopolistic competition with a differentiated intermediate good and variable elasticity of technological substitution. The model allows to study the nature and origins of external increasing returns. We single out two sources of scale economies: specialization and competition. The former depends only on how total factor productivity (TFP) varies with input diversity, while the latter is fully captured by the behavior of the elasticity of substitution across inputs. This distinction gives rise to a full characterization of the rich array of competition regimes in our model. The necessary and sufficient conditions for each regime to occur are expressed in terms of the relationships between TFP and the elasticity of substitution as functions of the input diversity. Moreover, we demonstrate that, despite the folk wisdom resting on constant elasticity of substitution models, specialization economies are in general neither necessary nor sufficient for external increasing returns to emerge. This highlights the profound and nontrivial role of market competition in generating agglomeration economies and other phenomena driven by scale economies.