Multi-product firms and increasing marginal costs

Abstract

Recent literature has addressed how product creation amplifies economic fluctuations via the love of variety. Yet, the empirical evidence on variety effects is sparse. The current paper demonstrates that decreasing returns in the variety-level production technology, which leads to increasing marginal costs, similarly amplify business cycles. Product scope expansions reduce marginal costs and firms have an incentive to produce multiple products even if the variety effects are entirely absent. The efficiency gains from adjusting product scopes makes the economy more susceptible to sunspot equilibria. The indeterminate model is estimated via Bayesian methods and data favors the multi-product structure with animal spirits explaining a significant fraction of U.S. business cycles.