Bigger Is Better: Market Size, Demand Elasticity And Innovation
This paper proposes a novel mechanism whereby larger markets increase competition and facilitate process innovation. Larger markets, in the sense of more people or more open trade, support a larger variety of goods, resulting in a more crowded product space. This raises the price elasticity of demand and lowers mark-ups. Firms, therefore, become larger to break even. This facilitates process innovation as larger firms can amortize R&D costs over more goods. The authors demonstrate this mechanism in a standard model of process and product innovation. In doing so, they question some important results in the new trade and endogenous growth literatures.