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Subsidy and product diversity in the presence of buyer power

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  • Zhiqi Chen
  • Hong Ding

Abstract

This paper analyzes the effectiveness of government subsidies in promoting product diversity when a downstream firm has buyer power. Using an extension of the Dixit‐Stiglitz model of monopolistic competition, we compare the effects of subsidies on the equilibrium number of differentiated products and social welfare in the case where products are sold directly to consumers versus the case where they are distributed through a monopoly retailer with buyer power. We find that a production subsidy promotes product diversity in both cases, but the mechanisms through which a subsidy raises the number of products are different. Compared with the case where products are distributed directly to consumers, retailer buyer power reduces product diversity and social welfare. Furthermore, it weakens the effectiveness of the subsidy in promoting product diversity. At any given subsidy rate the equilibrium number of products is smaller, and a rise in the subsidy rate leads to a smaller increase in the number of products.

Suggested Citation

  • Zhiqi Chen & Hong Ding, 2022. "Subsidy and product diversity in the presence of buyer power," International Studies of Economics, John Wiley & Sons, vol. 17(3), pages 278-295, September.
    • Handle: RePEc:wly:intsec:v:17:y:2022:i:3:p:278-295
    DOI: 10.1002/ise3.10
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    References listed on IDEAS

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    1. Michael Spence, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 43(2), pages 217-235.
    2. Zhiqi Chen, 2019. "Supplier Innovation In The Presence Of Buyer Power," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 60(1), pages 329-353, February.
    3. Aubert, Cècile & Bardhan, Pranab & Dayton-Johnson, Jeff, 2003. "Artfilms, Handicrafts and Other Cultural Goods: The Case for Subsidy," Department of Economics, Working Paper Series qt62n4f3bh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    4. Chen, Zhiqi, 2003. "Dominant Retailers and the Countervailing-Power Hypothesis," RAND Journal of Economics, The RAND Corporation, vol. 34(4), pages 612-625, Winter.
    5. Yang, Xiaokai & Heijdra, Ben J, 1993. "Monopolistic Competition and Optimum Product Diversity: Comment," American Economic Review, American Economic Association, vol. 83(1), pages 295-301, March.
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