The effects of inflation on the number of firms and firm size

Abstract

A typical money and growth model generally incorporates an implicit assumption that the number of firms (or the set of goods available) is fixed. This paper attempts to investigate the implications of relaxing this assumption in a monopolistically competitive model with endogenous markup. It is found that among other effects, inflation reduces the number of firms and each firm's size; moreover, due to this new channel, inflation induces secondary effects. One direct implication is that the welfare costs of inflation in our framework are substantially higher than those documented in existing models with standard features. Our findings suggest that it is the lessening of competition that appears to be the primary driving force.