Working Papers
Are Markups Too High? Competition, Strategic Innovation, and Industry Dynamics (with Murat Alp Celik and Xu Tian) [pdf]
R&R Review of Economic Studies (2nd round)
To study competition, innovation, and industry dynamics that arise as a result of their interaction, we develop a new oligopolistic general-equilibrium Schumpeterian growth model. This model ties together the endogenous growth, oligopolistic competition, and dynamic industrial organization literatures in a single unified framework, which is used to assess the growth and welfare implications of counterfactuals. Within each industry, there are an endogenously determined number of large firms (“superstars”) that compete à la Cournot and a continuum of small firms which collectively constitute a competitive fringe. Firms dynamically choose their innovation strategies, cognizant of other firms’ choices, and their entry and exit are endogenous. The model is consistent with the macroeconomic trends observed in the United States since the 1970s, such as the domination of industries by a small number of superstar firms, the rise of markups, market concentration, profits, and R&D spending, and the decline in business dynamism, productivity growth, and the labor share. It replicates the empirical relationship between innovation and competition within and across industries. As an application, we estimate the model to disentangle the effects of separate mechanisms on the structural transition observed in the United States, which yields striking results: (1) While the increase in the average markup causes a significant static welfare loss, this loss is overshadowed by the dynamic welfare gains from increased innovation in response to higher profit opportunities. (2) The increasing costs of innovation are found to be the primary determinant of lackluster productivity growth, i.e., ideas are getting harder to find.
A Theory of Dynamic Product Awareness and Targeted Advertising (with Murat Alp Celik, Jesse Perla and Pau Roldan-Blanco) [pdf]
R&R Journal of Political Economy
Rapid technological advances in advertising have enabled firms to better target those consumers most likely to buy their products. While more efficient than traditional methods, targeted advertising may significantly limit product market competition. We develop a novel framework of demand as a network, where heterogenous consumers dynamically become ``aware'' of differentiated products, expanding their choice sets and improving on their possible matches thanks to advertising. As networks become denser, customer misallocation decreases due to better sorting. However, though more intensive targeting can efficiently sort with fewer network connections, it also increases market power by segmenting consumers. Despite the rich micro structure, we show that the model aggregates to a neoclassical growth economy with endogenous TFP. As an application, we consider the case of the United States over a period of time which saw a rapid rise in digital advertising. We find that this rise led to substantially better consumer-firm matches. However, if the targeting technology had not improved during this period, markups would have been lower and welfare higher despite worse sorting.
Style Over Substance? Advertising, Innovation and Endogenous Market Structure (with Murat Alp Celik, Pau Roldan-Blanco and Xu Tian) [pdf]
R&R Journal of Monetary Economics
Firms use both innovation and advertising to increase their profits, markups, and market shares. While these two investments serve the same purpose from the firms’ perspective, their broader implications vary substantially. In this paper, we study the interaction between these two intangible inputs and analyze the implications for competition, industry dynamics, economic growth, and social welfare. To this end, we develop an oligopolistic general-equilibrium growth model with firm heterogeneity in which market structure is endogenous, and firms’ production, innovation, and advertising decisions interact strategically. We estimate the model to fit the non-linear relationship between innovation, advertising, and market share observed in the data. We find that advertising has significant macroeconomic effects: it improves static allocative efficiency through reducing misallocation, but it also depresses economic growth through a substitution effect with R&D. On the net, advertising is found to be welfare-improving. It is responsible for one quarter of the observed average net markup and its dispersion. We next study the optimal linear taxation/subsidization of advertising. We find that the optimal advertising tax is quite high. Such taxation could simultaneously increase dynamic efficiency, contain excessive spending on advertising due to an inefficient rat race between firms, and raise revenue while still maintaining most of the benefits of advertising via improving efficiency in resource allocation.
Climate Change, Directed Technical Change and Exhaustible Resources [pdf]
Data show increasing oil extraction rates accompanied by increasing proven reserves over the last decades. This suggests the existence of research by oil companies aimed at increasing their stocks (e.g. exploration or improved extraction techniques). Increasing oil prices act as an incentive to perform that kind of research and hence potentially postpone the development of clean alternative energies. This has consequences for optimal environmental policies. We propose a model of directed technical change with clean and dirty energy in production which is able to replicate the recent trends in the data on oil production and reserves. Our results show that ignoring research in extraction technologies leads to suboptimal climate policy and in particular carbon taxes that are too high and research subsidies that are too low.