The "Matthew Effect" and Market Concentration: Search Complementarities and Monopsony Power

Jesús Fernández-Villaverde, Federico S. Mandelman, Yang Yu, and Francesco Zanetti
Working Paper 2021-4
January 2021

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Abstract: This paper develops a dynamic general equilibrium model with heterogeneous firms that face search complementarities in the formation of vendor contracts. Search complementarities amplify small differences in productivity among firms. Market concentration fosters monopsony power in the labor market, magnifying profits and further enhancing the output share of high-productivity firms. The combination of search complementarities and monopsony power induce a strong "Matthew effect" that endogenously generates superstar firms out of uniform idiosyncratic productivity distributions. Reductions in search costs increase market concentration, lower the labor income share, and increase wage inequality. The model also transforms short-lived negative aggregate shocks into persistent recessions that heighten market concentration.

JEL classification: C63, C68, E32, E37, E44, G12

Key words: market concentration, superstar firms, search complementarities, monopsony power in the labor market

The authors gratefully acknowledge Michael Peters for an outstanding discussion and most helpful suggestions to simplify our analysis, as well as Luis Garicano and Gustavo Ventura for insightful comments. Ryan Zalla provided outstanding research assistance. Zanetti gratefully acknowledges financial support from the British Academy. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Jesús Fernández-Villaverde, University of Pennsylvania, 133 South 36th Street, Philadelphia, PA 19104; Federico Mandelman, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA, 30309; Yang Yu, Shanghai University of Finance and Economics, 318 Wuchuan Road, Shanghai, China; or Francesco Zanetti, University of Oxford, Manor Road, Oxford, OX1 3UQ, United Kingdom.

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