Marketing, Market Power, and Welfare

Since the mid-1990s, the United States has experienced a joint rise in aggregate marketing intensity and in the correlation between firms’ marketing-to-production cost ratios (MPCR) and markups. I develop a dynamic general equilibrium model with heterogeneous firms and endogenous markups in which marketing serves as a signal of unobserved product quality. The model shows that more scalable marketing technologies-such as those enabled by the Internet-intensify signaling competition, raising both the MPCR-markup correlation and aggregate marketing intensity. Calibrated to U.S. data, a 40% increase in the scalability of marketing technology accounts for these patterns but generates welfare losses of about 1.7% of steady-state consumption.

Comparing the market equilibrium with the constrained-efficient allocation, I show that information frictions and variable markups jointly depress entry and productivity. Targeted policies-such as size-dependent subsidies and entry support-can mitigate these distortions and deliver substantial welfare gains.