DP751 | Multiple Equilibria in a Growth Model with Monopolistic Competition


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We develop a simple growth model with imperfect competition in which demand conditions can affect the dynamics of capital accumulation, hindering or enhancing growth. In our model the elasticity of the demand schedule faced by a typical firm depends on the aggregate savings rate. The latter feature results from a wedge between the elasticity of substitution across inputs in productive activities and the elasticity of substitution across goods in consumption. When the demand elasticity is constant or inversely related to the savings rate the equilibrium dynamics are shown to be qualitatively identical to those found in the perfectly competitive one-sector growth model: there is a unique stationary equilibrium which is saddle-point stable. In contrast, when the demand elasticity is positively related to the savings rate, multiple stationary equilibria (as well as multiple non-stationary equilibrium paths converging to them) emerge for some parameter values. In the latter case, the model can account for permanent differences in per capita income across homogeneous economies (even when the initial conditions are identical), as well as the absence of capital flows from rich to poor countries.