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. We demonstrate this mechanism in a standard model of process and product innovation. In doing so, we question some important results in the new trade and endogenous growth literatures.
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Paper provided by Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales in its series Working Papers with number
2008-10.
Length: Date of creation: 27 Oct 2008 Date of revision: Publication status: Forthcoming in International Economic Review Handle: RePEc:imd:wpaper:wp2008-10