Serene Tan, NUS
This paper proposes a theory endogenizing the market structure when buyers’ incomes are heterogeneous. Using a directed search model, ex ante identical firms choose the product quality of a good to sell and the target audience it wants to sell to, knowing only the income distribution of buyers. I show how the income distribution of buyers matters in determining the market structure. Segmentation of the product market by buyer income type can be obtained as an equilibrium phenomenon, but need not be. Firms respond to changes in income inequality by potentially changing not just prices, but also the qualities offered for sale. Firms’ markups depend on income inequality, and worsening income inequality may manifest in higher markups. Due to the endogeneity of the market structure, this paper makes explicit how changes in income inequality matter for agents’ welfare.
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