Paper #953

Title:

Increasing returns, imperfect competition and factor prices

Authors:

Paolo Epifani and Gino Gancia

Date:

July 2004 (Revised: October 2005)

Abstract:

We show how, in general equilibrium models featuring increasing returns, imperfect competition and endogenous markups, changes in the scale of economic activity affect income distribution across factors. Whenever final goods are gross-substitutes (gross- complements), a scale expansion raises (lowers) the relative reward of the scarce factor or the factor used intensively in the sector characterized by a higher degree of product differentiation and higher fixed costs. Under very reasonable hypothesis, our theory suggests that scale is skill-biased. This result provides a microfoundation for the secular increase in the relative demand for skilled labor. Moreover, it constitutes an important link among major explanations for the rise in wage inequality: skill-biased technical change, capital-skill complementarities and international trade. We provide new evidence on the mechanism underlying the skill bias of scale.

Keywords:

Endogenous Markups, Pro-competitive E¤ect, Income Distribution, Trade Models with Imperfect Competition, Wage Inequality

JEL codes:

F12, F16

Area of Research:

Macroeconomics and International Economics

Published in:

Review of Economics and Statistics 88, 583-598, 2006

Download the paper in PDF format