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CEP discussion paper

Efficiency in large markets with firm heterogeneity

Abstract Empirical work has drawn attention to the high degree of productivity differences within industries, and its role in resource allocation. In a benchmark monopolistically competitive economy, productivity differences introduce two new margins for allocational inefficiency. When markups vary across firms, laissez faire markets do not select the right distribution of firms and the market-determined quantities are inefficient. We show that these considerations determine when increased competition from market expansion takes the economy closer to the socially efficient allocation of resources. As market size grow large, differences in market power across firms converge and the market allocation approaches the efficient allocation of an economy with constant markups.

Swati Dhingra and John Morrow

12 October 2017     Paper Number CEPDP1502

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This CEP discussion paper is published under the centre's Trade programme.