XII. Monopoly pricing and limited needs

The basic idea: Take a Dixit-Stiglitz type model If utility is non homothetic, the markup depends on how much of each good is consumed TFP growth changes that amount The markup changes, and thus the distribution of income between profits and wages

The central result If utility is bounded (limited needs), then there is a negative relationship between the consumption level and the demand elasticity Growth may therefore be detrimental to workers

The model

Isoelastic utility The markup is constant Wages are proportional to productivity So are profits TFP growth has no effect on the factor distribution of income

Non homothetic utility

Monopoly pricing

The limited needs property: Assume u() is bounded The price-elasticity of demand gets arbitrary low when consumption goes up to arbitrary levels People are near-satiated Not willing to pay much for the good But even less sensitive to proportional changes in its price

Consequence: As the economy gets richer, total elasticity of demand goes down arbitrarily The markup becomes arbitrarily large Wages must become lower over some range Rise in markup more than offsets rise in productivity

Example:

Figure 9.1: Effect of productivity on wages Real wages Productivity

Interpretation Wages grow less than proportionally to productivity Profits grow more than proportionally In the Marxian zone, wages fall: more than 100 % of GDP growth appropriated by profits Workers consume the same goods as capitalists, and the latter exert a negative externality on the former by being careless consumers as GDP goes up

Introducing new varieties A larger N reduces consumption of each variety People are less satiated, and elasticity goes up Markups fall, and wages go up More TFP is needed to enter the Marxian zone Furthermore, incentives to introduce new goods larger when a goes up

From capitalists to knowledge workers Take the basic Roy specialization model Assume that human capital is used to produce new blueprints Competition among R and D firms links profits with return to human capital A rise in a raises the returns to H More people become knowledge workers

Extending the model

Dynamics Number of varieties grows endogenously TFP grows exogenously Productivity at inventing a new variety grows exogenously at the same rate Consumers allocate their intra-period expenditures by maximizing intra-period utility  same determination of markets Intertemporal optimization of the profile of expenditures

Balanced growth path

Balanced growth kills the Marxian result Along the BGP, ω and w grow at the same rate Distribution of income invariant Growth in N offsets growth in A and markups remain constant But a once-and-for-all jump in A increases inequality Thus, it is imbalances between TP in the production of goods and TP in the production of knowledge that matters

Figure 9.2: Impact of an increase in total factor productivity ω/w H/L

Figure 9.3: Impact of productivity growth on the distribution of wages, in a Solovian zone. Income Productive workers Creative workers A B Skill

Figure 9.4: Impact of productivity growth on the distribution of wages, in a Marxian zone Income A B Skill

Globalization Two countries, home vs. Foreign They differ in labor endowments and productivity levels Under autarky, no trade and a fixed number of firms Under globalization, trade in goods and firms can relocate to equalize profits

Some workers may lose from globalization… Firm mobility equalizes labor costs across countries Goods mobility implies there is a single markup for each good worldwide, which by symmetry is the same across firms A country may lose from globalization in Ph.P.P. terms because it faces a higher markup But it gains from greater diversity

…and these workers may be in the poorer country Markup goes up if world consumption of the good is higher than autarkic consumption Will be the case in the least productive country if number of brands is initially not too small there

Symmetrical equilibrium

Comparing with Autarky