Abstract
Most existing theoretical studies on home market effects depend crucially on the assumption of increasing returns to scale technology. This paper studies the consequences of the absence of increasing returns to scale on home market effects by employing a constant returns monopolistic competition model. This paper demonstrates that home market effects can emerge or disappear depending on the magnitude of the elasticity of substitution and transport costs even in the constant returns model with firm mobility. In particular, a reverse home market effect can result when the elasticity of substitution is low and transport costs are high.
Highlights
This paper studies the consequences of the absence of increasing returns to scale on home market effects by employing a constant returns monopolistic competition model
This paper demonstrates that home market effects can emerge or disappear depending on the magnitude of the elasticity of substitution and transport costs even in the constant returns model with firm mobility
This is known as the “home market effect” (HME)
Summary
Most existing theoretical studies on the HME depend crucially on the assumption of increasing returns to scale (IRS) and monopolistic competition (as in Helpman and Krugman [2]). In the theoretical literature on HMEs, Davis [7], Head, Mayer and Ries [8], Yu [9], and Larch [10] extend the model of Helpman and Krugman [2] by making additional assumptions and find that the opposite effect of the HME can emerge. All these studies rely on the assumption of IRS to examine the HME.
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