Oligopolistic Competition, Product Variety and International Trade

This paper develops a model of industrial structure and product variety when technology is characterized by increasing returns to scale. Unlike theories of increasing returns in markets that are contestable, we assume here that an entrant must incur a fixed cost prior to entering the market. Pricing and output decisions occur subsequently. When entry and pricing decisions are sequential in this way the nature of the resulting market equilibrium is quite different from that which arises when they are simultaneous. Product variety is likely to be lower and there is room for excess profits. The paper explores the implications of the opening of trade when one industry is characterized by this market structure. The possibility of trade can reduce product variety even if trade does not actually ever take place. Examples of trade leading to a Pareto inferior outcome are found.Published in connection with a visit at the IIE