Monopoly power, increasing returns to variety, and local indeterminacy

The required degree of increasing returns-to-scale to satisfy the Benhabib–Farmer condition for local indeterminacy is too high to be empirically plausible. In the paper, we develop a natural extension of Benhabib and Farmerʼs (1994) model by introducing aggregation increasing returns to variety. It is shown that an increase in the degree of monopoly power can create increasing returns to an expansion in variety which decreases reliance on the degree of increasing returns-to-scale in production for generating local indeterminacy. As the degree of monopoly power increases, the required degree of increasing returns for local indeterminacy decreases monotonically. As a result, our numerical analysis indicates that the required degree of increasing returns for local indeterminacy can be easily located in the empirically plausible range.