The Price Index Effect, Entry and Endogenous Markups in a Macroeconomic Model of Monopolistic Competition

Models of imperfect competition contain the possibility of multiple equilibria when the markup of price over marginal cost is negatively dependent on activity. The model most often used in applied work, the Dixit and Stiglitz (1977) model, is usually thought not to be able to produce such an effect. However, this paper presents a macroeconomic model where free market entry of firms is considered in the generalized version of that model, originally due to Yang and Heijdra (1993) and d'Aspremont et al. (1996). A price index effect makes the markup depend on the number of firms which in turn depends on activity, so there may be multiple equilibria in this economy