Market Size, Demand Elasticity and Innovation

EFIGE IS A PROJECT DESIGNED TO HELP IDENTIFY THE INTERNAL POLICIES NEEDED TO IMPROVE EUROPE’S EXTERNAL COMPETITIVENESS

Klaus Desmet and Stephen L. Parente

Bigger is better: market size, demand elasticity and innovation

EFIGE working paper 06 April 2009

LEGAL NOTICE: The research leading to these results has received funding from the European Community's Seventh Framework Funded under the Programme (FP7/2007- Socio-economic 2013) under grant Sciences and agreement n° 225551. Humanities The views expressed in Programme of the this publication are the Seventh sole responsibility of the authors and do not Framework necessarily reflect the Programme of the views of the European European Union. Commission.

The EFIGE project is coordinated by Bruegel and involves the following partner organisations: Universidad Carlos III de Madrid, Centre for Economic Policy Research (CEPR), Institute of Economics Hungarian Academy of Sciences (IEHAS), Institut für Angewandte Wirtschafts- forschung (IAW), Centro Studi Luca D'Agliano (Ld’A), Unitcredit Group, Centre d’Etudes Prospectives et d’Informations Internationales (CEPII). The EFIGE partners also work together with the following associate partners: Banque de France, Banco de España, Banca d’Italia, Deutsche Bundesbank, National Bank of Belgium, OECD Economics Department. $XVVTg Xh $TiiTg 5Pg`Ti AXuT &TbPcS 'aPhiXRXit PcS 1ccdqPiXdc

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Equilibrium Technology

15 Elasticity (Population 150) 14 1+(1+gamma)phi

13 Elasticity (Population 250)

7 0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 Technology Progress (gamma)

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) ,! # +

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Trade Liberalization and Technological Progress

1% Technological Progress (gamma)

0% 1.25 1.20 1.15 1.10 1.05 1.00 Trade Openness (tau)

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- + # ./

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