Market structure and fiscal policy effectiveness

In a monopolistic competition macromodel with endogenous market structure, the fiscal multiplier is shown to consist of two components. The first depicts the response of output to a fiscal expansion through the conventional channels that disregard the role of market imperfections. The second component captures the effects of firms' market power as well as the policy-induced change in market structure. The latter effect-which has not been taken into account in existing studies-is shown to be quite significant in raising the fiscal multiplier (even above unity) and in improving consumers' welfare when the labour market is competitive.