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:

Productivity

Real wages

Figure 9.1: Effect of productivity onwages

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

H/L

ω/w

Figure 9.2: Impact of an increase in total factorproductivity

Skill

Income

Creativeworkers

Productiveworkers

Figure 9.3: Impact of productivitygrowth on the distribution of wages,in a Solovian zone.

A B

Skill

Income

Figure 9.4: Impact of productivitygrowth on the distribution of wages,in a Marxian zone

A B

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