Abstract
The paper brings together two strands of the New Keynesian literature: search externalities and impeifect competition. In the model of the paper, agents engage in costly search in order to form firms, which then compete in an imperfectly competitive environment. Search thus plays the role of an endogenous entry cost, and the degree of imperfect competition is likewise endogenous. The main result of the paper is that, since the externalities from search include its effects on the degree of market power, increased search by one agent imposes net negative externalities on potential partners. The increased probability of being matched is outweighed by lower expected profits. The endogeneity of the degree of market power also magnifies the multiplier effects associated with demand shocks in the product market.
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