Will AI Intensify or Weaken Market Competition?

Abstract

We study how AI affects market competition based on a general equilibrium framework with heterogeneous firms facing idiosyncratic productivity and variable markups. Firms choose the AI technology subject to fixed costs, where AI production requires data and energy inputs. Our model predicts a non-monotonic relation of AI diffusion with industry concentration. As AI usage rises from an initially low level, large incumbent users gain market share. When AI usage is sufficiently diffused, entry of new and smaller adopters erodes the market share of incumbents, reducing industry concentration. The non-monotonic relations are robust when firms can complement AI with their own data. Our calibrated model predicts that industry concentration is likely to fall if AI adoption increases relative to the current level. In comparison, the relation of AI with the average markup depends on whether increased AI usage is driven by demand or supply factors. Our model also predicts that a modest subsidy of about 3 percent for AI adopter revenues maximizes social welfare, reflecting a tradeoff between aggregate productivity and the average markup associated with AI usage.