Price-cost margins and firm size under monopolistic competition: The case of IES preferences

We introduce a class of “increasing elasticity of substitution” preferences in a monopolistic competition setting à la Dixit and Stiglitz (1977). Contrary to the standard view, we find that a market which is widening, as a result of, for example, international trade, increases price-cost margins and reduces firm sizes. However, even if prices are higher (with constant marginal costs), consumers benefit from the market expansion because of higher product diversity (the free-entry equilibrium has a sub-optimal number of varieties). Our results might contribute to explain the puzzle posed by the movements of markups following globalisation. They could also help explaining the cyclical behaviour of prices.