Home Market Effects: Beyond the Constant Elasticity of Substitution

Abstract

This paper aims to fill the gap between the theoretical and empirical studies of the home market effect (HME). On the one hand, empirical studies on the price aspect of the HME that the wage is higher in the larger market are supportive but studies on the quantity aspect that the firm share in the larger market is more than proportionate is highly mixed. On the other hand, most existing theoretical studies support the quantity aspect but neglect the price aspect. By incorporating the additively quasi-separable constant absolute risk aversion utility in a footloose capital model, we are able to capture the pro-competitive effect and the income effect together and examine the HME. The new theoretical results are consistent with the empirical studies. We also obtain some interesting results regarding the variable markups.