Generative AI as a Non-Convex Supply Shock: Market Bifurcation and Welfare Analysis

2026-01-18

AI Summary

This study addresses how generative artificial intelligence (GenAI)—a non-convex supply shock characterized by zero marginal cost and negative externalities from information pollution—reshapes market structure, transition dynamics, and social welfare. Building a three-tier general equilibrium framework that integrates a static vertically differentiated product model, a mean-field evolutionary system, and calibrated simulations of boundedly rational agents, the paper uncovers a tripartite market segmentation into exit, AI-dominated, and human-resilient sectors, alongside a phenomenon of “middle-class hollowing.” The analysis reveals that the economic transition follows a non-monotonic path, marked by an initial ecological collapse followed by selective recovery. Humans reposition themselves by shifting toward semantic creativity, yet under high information pollution, further AI expansion paradoxically reduces aggregate welfare, underscoring the critical need for congestion management on the production side.

Technology Category

• Game Theory and Economic Paradigms: Auctions and Market-Based Systems
• Philosophy and Ethics of AI: Artificial General Intelligence
• Humans and AI: Other Foundations of Human Computation & AI

Application Category

• Economics, Online Markets and Human Computation: Economic ramifications for generative AI infrastructure and applications
• Social Networks and Social Media: Generative AI / large language models and their impact on social systems
• Semantics and Knowledge: Data modeling to support human-machine intelligence, including LLMs agents, intelligent system behavior, explanations, and user-friendly interactions

Abstract

The diffusion of Generative AI (GenAI) constitutes a supply shock of a fundamentally different nature: while marginal production costs approach zero, content generation creates congestion externalities through information pollution. We develop a three-layer general equilibrium framework to study how this non-convex technology reshapes market structure, transition dynamics, and social welfare. In a static vertical differentiation model, we show that the GenAI cost shock induces a kinked production frontier that bifurcates the market into exit, AI, and human segments, generating a ``middle-class hollow''in the quality distribution. To analyze adjustment paths, we embed this structure in a mean-field evolutionary system and a calibrated agent-based model with bounded rationality. The transition to the AI-integrated equilibrium is non-monotonic: rather than smooth diffusion, the economy experiences a temporary ecological collapse driven by search frictions and delayed skill adaptation, followed by selective recovery. Survival depends on asymmetric skill reconfiguration, whereby humans retreat from technical execution toward semantic creativity. Finally, we show that the welfare impact of AI adoption is highly sensitive to pollution intensity: low congestion yields monotonic welfare gains, whereas high pollution produces an inverted-U relationship in which further AI expansion reduces total welfare. These results imply that laissez-faire adoption can be inefficient and that optimal governance must shift from input regulation toward output-side congestion management.

Problem

• Generative AI
• supply shock
• congestion externalities
• market bifurcation
• welfare analysis

Innovation

• Generative AI
• non-convex supply shock
• market bifurcation
• congestion externality
• evolutionary equilibrium