Economic growth and economic development 576

Introduction to Modern Economic Growth
It is then straightforward to see that the entry condition that determines the number
of varieties in the market will change to
Ã
N

ε
− ε−1

γψ m − v

0−1

Ã

1

N ε−1
γψ

!!

= µ.

12.4.4. Limitations. The most important limitation of the Dixit-Stiglitz model
is the feature that makes it tractable: the constancy of markups as in equation
(12.12). In particular, the model implies that the markup of each firm is independent of the number of varieties in the market. But this is a very special feature. Most
industrial organization models imply that markups over marginal cost are declining
in the number of competing products (see, for example, Exercise 12.14). While plausible, this makes endogenous growth models less tractable, because in many classes
of models, endogenous technological change will correspond to a steady increase in
the number of products N. If markups decline towards zero as N increases, this

would ultimately stop the process of innovation and thus prevent sustained economic growth. The alternative would be to have a model in which some other variable, perhaps capital, simultaneously increases the potential markups that firms can
charge. While such models are possible, they are more difficult than the standard
Dixit-Stiglitz setup. For this reason, the literature typically focuses on Dixit-Stiglitz
specifications.

12.5. Individual R&D Uncertainty and the Stock Market
The final issue we will discuss in this chapter involves uncertainty in the research
process. As discussed at the beginning of the chapter, it is reasonable to presume
that the output of research will be uncertain. This implies that individual firms
undertaking research will face a stochastic revenue stream. When individuals are
risk averse, this may imply that there should be a risk premium associated with
such stochastic streams of income. This is not necessarily the case, however, when
the following three conditions are satisfied:
(1) there are many firms involved in research;
(2) the realization of the uncertainty across firms is independent;
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