Economic growth and economic development 575

Introduction to Modern Economic Growth
imply that firms do not take into account the positive benefits their entry creates
on other firms, the business stealing effect implies that entry may also reduce the
demand for existing products. Thus, in general, whether there is too little or too
much entry in models of product differentiation depends on the details of the model
and the values of the parameters (see Exercise 12.13).

12.4.3. Limit Prices in the Dixit-Stiglitz Model. We have already encountered how limit prices can arise in the previous section, when process innovations are
non-drastic relative to the existing technology. Another reason why limit prices can
arise is because of the presence of a “competitive” fringe of firms that can imitate
the technology of monopolists. This type of competitive pressure from the fringe
of firms is straightforward to incorporate into the Dixit-Stiglitz model and will be
useful in later chapters as a way of parameterizing competitive pressures.
Let us assume that there is a large number of fringe firms that can imitate
the technology of the incumbent monopolists. Let us assume that this imitation
is equivalent to the production of a similar good and is not protected by patents.
It may be reasonable to assume that the imitating firms will be less efficient than
those who have invented the variety and produced it for a while. A simple way of
capturing this would be to assume that while the monopolist creates a new variety
by paying the fixed cost µ and then having access to a technology with the marginal
cost of production of ψ, the fringe of firms do not pay any fixed costs, but can only
produce with a marginal cost of γψ, where γ > 1.
Similar to the analysis in the previous section, if γ ≥ ε/ (ε − 1), then the fringe

is sufficiently unproductive that they cannot profitably produce even when the monopolists charge the unconstrained monopoly price given in (12.12). Instead, when
γ < ε/ (ε − 1), the monopolists will be forced to charge a limit price. The same
arguments as in the previous section establish that this limit price must take the

form
ε
ψ.

ε−1
561

p = γψ <