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Heterogeneous consumers and market structure in the monopolistically competitive setting
The leading contemporary concept to imitate the economic reality is the representative
agent approach (Kirman, 1992; Hartley, 1996; Acemoglu, 2009). It assumes that the choices of
the diverse agents can be considered as the choices of one utility maximizing individual whose
behavior coincides with the aggregate behavior of the heterogeneous individuals. To imitate the
demand side of the economy, the representative agent approach typically postulates the identical
and homothetic preferences for all consumers (Markusen, 2010). Such an assumption allows one
to greatly simplify the analysis and obtain transparent analytical results. Nevertheless its
justification has never been rigorously proven and still to be the hot area of discussions (Kirman,
In the present project an attempt is made to get rid of both the identity and homotheticity
of the consumer’s preferences. Using modified CES utility function depending on consumer’s
income, we investigate the impact of the personal income distribution on the market structure
and trade in the monopolistically competitive setting. The proposed approach extends the
traditional Dixit-Stiglitz and Dixit-Stiglitz-Krugman models and allows revealing the collective
effects of the consumer’s behavior both in the case of a closed and an open economy. Our model
does not appeal to the representative agent concept and has a wider range of applications
The present model does not assume all the firms to be identical. The firm heterogeneity is
also a natural and important element of our model.
Practical contribution of research
The endogenization of the market structure has always been a key topic of economic
research. Our project contributes to this issue, suggesting a major role of per-capita income
inequality. As it is well known, the personal income distribution sufficiently influences growth
performance, effects the imperfect capital markets and aggregate demand (Aghion et al, 1999;
Zweimueller, 2000). Besides, the significant increase in earning inequality (Caminada and
Goudswaard, 2001; Santos-Paulino, 2012) may serve as an alternative explanation of the rising
market concentration, which is traditionally explained by increased competition due to trade
liberalization. The idea of using income polarization as an alternative phenomenon explaining
increased market concentration is not new; it was put forward and studied earlier, but it was
made on the basis of a simpler model (Benassi et al, 2002a). Taking into account the nonidentity
and non-homotheticity of consumer’s preferences caused by personal income inequality and its
influence on the market demand functions, one can investigate distributional effects in the
optimal behavior of firms and market equilibrium. In the case of open economy our approach
explains observed phenomena, concerning variations in bilateral trade due to difference in
income per capita between different countries, sufficiently improving predictions of standard
gravity models, which completely ignore the way of how total income is distributed among
The question of consumer’s preferences impact on market structure and international
trade is one of the urgent and widely discussed in the contemporary literature (Caron et al, 2011;
Choi et al, 2009; Dalgin et al, 2008; Fieler, 2011; Hsieh and Klenow, 2007; Hummels and
Lugovskyy, 2009; Markusen,2010; Simonovska, 2010). Its urgency can be attributed to both the
success of the theoretical analysis and accumulation of the empirical facts, which cannot be
satisfactorily explained by the traditional models. The rising interest towards this problem was
also promoted by historical reasons. Until recently the most of trade theory tended to focus on
the supply side determinants of trade. So far as the demand side is concerned, it was analyzed
using crude approximation. It was typically assumed that consumers have identical and
homothetic preferences within and across countries (Markusen, 2010; Brakman and Heijdra,
2004). Besides, aggregate demand was supposed to depend only upon commodity prices and
aggregate income and not dependent on the distribution of income. Such an assumption was used
due to analytical convenience and tractability. It sufficiently simplifies calculations, but have a
lot of shortcomings and empirically implausible (Kirman, 1992; Hartley, 1996; Markusen, 2010).
In the meantime, though, appear a lot of publications, trying to take into account the
One of the most influential papers of that kind is the Melitz attempt to model
heterogeneous firms (Melitz, 2003) on the basis of the Dixit-Stiglitz approach. Melitz model has
well described a new transmission channel for the impact of trade on industry structure and
explained how the exposure to trade induces only the more productive firms to export while
simultaneously forcing the list productive ones to exit. The empirical work has confirmed the
importance of revealed channel for understanding effects of trade on firm and industry
So far as heterogeneity of demand is concerned there is also some progress. The leading
proponents of taking specificity of consumer’s preferences into account when explaining market
structure and international trade effects are Corrado Benassi (Benassi et al, 2002a; Benassi et al,
2002b; Benassi and Chirco, 2004; Benassi et al, 2005; Benassi et al, 2006) and James Markusen
(Markusen, 1986; Markusen and Venables, 1988; Markusen and Wigle, 1990).
The paper of Benassi et al (2002a) focuses on the effects of income polarization and
presents a model, demonstrating how income inequality leads to market concentration, i.e., to a
smaller number of firms able to survive in the long run. In accordance with Benassi’s idea,
income polarization may well be among the reasons why market concentration has been
increasing (at least in some sectors) over the last decades.
In the paper of Benassi et al (2002b) the authors analyze the opposite effects caused by
income heterogeneity. They show how income concentration and income dispersion may affect
market demand and its elasticity. Following an increase in income concentration towards the
middle (measured by variations in mean preserving spread) the increase in demand faced by
firms can be associated with an increase in price elasticity. Accordingly, the positive effects of
the size of the market becoming wider are amplified by a higher degree of competition. As
incomes become more concentrated around the given mean, market demand and its elasticity
both increase for a relevant intermediate range of prices. In this sense, the existence of a large
middle class may support a more competitive market environment, conductive to lower
The paper of Benassi and Chirco (2004) studies under what distributional conditions the
“Robinson effect” holds – i.e. the relationship between income and elasticity at the individual
level translates at the market level. The authors have shown that there is a wide range of shocks,
which can be interpreted as generalized increases in income, and which preserve at the aggregate
level the sign of the relationship between income and price elasticity observed at the individual
level. The main property which identifies these shocks is that they increase the share of demand
accruing to richer consumers. Even though, as Joan Robinson reasonably conjectured, price
elasticity decreases with income at the individual level, a generalized increase in income may be
associated with an increase in market demand elasticity, provided it translates itself into an
increase of the demand of low-income consumers, such that their share in overall demand
increases: a poor-middle class oriented increase in income could then bring about a contraction
In the paper of Benassi et al (2005) the non-homothetic preferences are introduced into
the Dixit-Stiglitz model of monopolistic competition to investigate the effects of change in
income dispersion on the firm’s optimal decisions and market equilibrium. Income dispersion,
modeled as a mean preserving spread, is shown to affect only the degree of product
differentiation under the standard negligibility hypothesis on the firms’ decision making process,
while it generates a positive co-movement of demand and demand elasticity, when this
assumption is removed and the price index effect is taken into account.
Many interesting and important results, concerning relation between the consumer’s
preferences, market structure and trade, have been obtained in James Markusen’s works
(Markusen, 1986; Markusen and Venables, 1988; Hunter and Markusen, 1988; Markusen and
Wigle, 1990; Markusen, 2010). Using non-homotheticity of preferences assumption, Markusen
proposed an alternative explanation for the number of diverse trade phenomena, such as growing
wage gaps, the mystery of the missing trade, home bias in consumption, and the role of intra-
country income distribution, solely from the demand side of general equilibrium. The model
developed by Markusen (2010), were aiming to explain higher mark-ups and higher price levels
in higher per-capita income countries. His results in some sense are similar to those found in
Hammels and Lugovskyy (2009) and Simonovska (2009), which is that mark-ups and hence the
price level will be higher in higher per-capita income country. Simonovska gets strong empirical
support for this relationship, also found in earlier papers including Hsieh and Klenow (2007).
Essentially the same result was found in Wong (2003) for pricing of identical pharmaceutical
Dalgin et al (2008) paper proves that inequality is an important determinant of import
demand. The authors interpret this fact with the aid of a model in which tastes are non-
homothetic. Using the correlation between household budget shares in the US and income, they
classify products into luxuries and necessities and show that while the imports of luxuries
increase with the importing country's inequality, imports of necessities decrease with it. They
also find that an increase in the level of inequality in the importing country generally leads to an
increase in imports from developed countries and to a reduction in imports from low-income
Similar results were obtained in the paper of Simonovska (2010), who presents evidence
from a clothing manufacturer that sells identical goods online to 28 countries and charges higher
prices in richer markets. The author stays that such price discrimination on the basis of income
suggests that firms exploit different price elasticities of demand across countries that differ in
income. In particular, if rich consumers are less responsive to price changes than poor ones,
firms find it optimal to price identical products higher in more affluent markets. In order to
capture this mechanism, Simonovska introduces non-homothetic preferences in a model of trade
with product differentiation and heterogeneity in firm productivity a la Melitz (2003) and
Methodology of research
The main body of our research is based on the theoretical model developed by the head of
the project, though empirical verifications of results are also implied. The main elements of our
model for the case of a closed economy are described below (extension for an open economy
There is a one-sector economy, the population of which is divided into K
being the number of individuals in the group k
is an income of the individual in
such a group. The preferences of any individual in the k
-th group are given by a modified CES
2 ., K
is the quantity of variety i
consumed by an individual with income
σ ≡ σ (y
) is a parameter, depending on the personal income of a consumer, N
is the total
number of varieties available (equal to the number of firms, each producing a different variety).
Maximizing the utility functions, subject to the consumer’s budget constraint, one can get
the individual demand functions, which aggregation provides the market demand for individual
varieties. The market demand functions are used then to derive the sufficient conditions for the
firm profit maximization. These conditions differ drastically from traditional ones and have a
form of N
simultaneous nonlinear algebraic equations:
is the constant marginal cost of firm i
(generally, firms are supposed to be
- coefficients, depending on the prices, number of firms N
, number of individuals
in the income groups L
, personal income levels y
, and parameter σ :
,σ ) . To get the optimal price vector
dependence upon the exogenous parameters of the model, this system could be solved by
Assuming, for simplicity, all firms to be identical and searching for the symmetric
equilibrium, one can get the analytical solution of the above system, and find equilibrium price
level, output of a firm, number of firms, price elasticity coefficients both for individual and
market demand curves. The key variable driving all these dependencies turns out to be the
= ∑λ y
is the average personal income, λ = L
is the income distribution (share
of the consumers with income y
in the total number of consumers). Given σ = σ ( y
λ = λ(y
) , one can obtain σ and then find the values of all the model parameters.
Formally, expressions for the optimal price level, output and number of firms in
heterogeneous case turn out to be quite similar to those in the Dixit-Stiglitz model (and coincide
with them in homogeneous case). Nevertheless, there is essential difference between the two
models. In the heterogeneous case the model parameters depend on the income distribution of
the consumers (which is obvious from expression for σ ), while in the homogeneous case they
don’t. This allows to study consumer’s collective behavior effects due to income distribution
transformation. For example, fixing the average income and changing income dispersion, one
can find the aggregate price, output of a firm, and firm number dependence upon the level of
inequality in economy. In the homogeneous case, where all consumers are supposed to be
identical (and collective behavior reduces to the behavior of an individual), this couldn’t be
The outlined model can be easily extended to investigate the trade effects in the open
economy case. Following the logic of the model one doesn’t need to assume the income and
preferences of the consumers being identical in different countries. Such an extension allows
getting some new results concerning relations between consumer’s preferences, market structure
and trade patterns in different countries. The analysis could be carried out both on the basis of
symmetric equilibrium with identical firms and in more general setting, where firms are
supposed to differ in their marginal costs.
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linking production and preferences”, NBER Working Paper No. 18131.
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Trade,” American Economic Review, vol. 98, No.4, 1707–1721.
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Distribution”, Journal of International Economics,
77, pp. 265-275.
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Trade: A Gravity Approach”, Southern Economic Journal,
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Feenstra (editor), Empirical Methods for International Economics
, Cambridge: MIT Press, pp.
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Journal of Economic Perspectives
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survey”, United Nations Conference on Trade and Development (UNCTAD), Didcussion papers
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Wong, E. (2003): “Pharmaceutical Drug Prices in the International Market”, PhD thesis,
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inequality in innovation-driven growth”, Journal of Economic Growth
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The research team includes two participants: Osharin A.M. (the head of the project) and
Verbus V.A., working with the former on the Faculty of the Economic Theory and Econometrics
of the Scientific Research University «Higher School of Economics» - Nizhny Novgorod. Both
participants occupy position of associate professors and have scientific degree. The basis for
cooperation is their joint teaching and research activity.
Alternative/additional sources of funding
The authors do not possess neither alternative, nor additional sources of financing the
project, except for wages (associate professors salary).
The project is planned to perform within 1.5 year period. At the first stage of the project
(approximately half a year) it is supposed to investigate heterogeneous consumer’s demand
impact on the monopolistically competitive markets in the case of a closed economy. For
identical firms this will be done analytically. The case of heterogeneous firms will be
investigated numerically. As an output of this stage the computer program accounting for all
needful parameters will be developed. The program is supposed to calculate the aggregate price,
output of a firm, optimal number of firms and price elasticity coefficients both for individual and
market demand curves as functions of income level inequality.
At the second phase of research (one year term) the model will be extended to an open
economy case and used to study interrelations between consumer’s income heterogeneity and
trade patterns. The open economy case will also be investigated both analytically (homogeneous
firms) and numerically (heterogeneous firms). The purpose of investigation, which is supposed
to perform for an open economy case, is in obtaining new results, concerning home market
effects for consumers having non-identical and non-homothetic preferences within and across
Hellenic J Cardiol 48: 296-299, 2007 Drug-Induced Long QT Syndrome K ONSTANTINOS P. LETSAS , MICHALIS EFREMIDIS , GERASIMOS S. FILIPPATOS , 1Second Department of Cardiology, Evangelismos General Hospital of Athens, 2Second Department of Cardiology,Atticon University Hospital of Athens, Athens, Greece. Key words: Drugs, long QT, torsades de pointes, sudden cardiac A continuously growi
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