On financial frictions and firm's market power

There are two opposing welfare effects of market power in a model with monopolistic competition, loan defaults and moral hazard. The loss of output produced if firms set a higher mark‐up over marginal costs confronts with some gain due to higher expected profits and the reduction of defaults. Such t...

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Bibliographic Details
Published in:Economic inquiry 2023-10, Vol.61 (4), p.982-1005
Main Authors: Casares, Miguel, Deidda, Luca G., Galdon‐Sanchez, Jose E.
Format: Article
Language:English
Subjects:
Bankruptcy
credit rationing
loan defaults
Marginal costs
market power
Moral hazard
Power
Profits
Rationing
Welfare
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Summary:There are two opposing welfare effects of market power in a model with monopolistic competition, loan defaults and moral hazard. The loss of output produced if firms set a higher mark‐up over marginal costs confronts with some gain due to higher expected profits and the reduction of defaults. Such tradeoff results in an optimal level of market power that decreases with the efficiency of liquidation following default on a loan. If moral hazard is pervasive, credit rationing cuts down the default rates and mitigates the welfare cost of financial frictions.
ISSN:0095-2583
1465-7295
DOI:10.1111/ecin.13146