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On Equilibrium in Monopolistic Competition

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  • Richard Carson

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    (Carleton University)

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    Abstract

    The price, output, and quality of a monopolistic competitor are determined by maximizing the difference between its revenue and its cost, where cost is measured exclusive of the rent on its product-specialized inputs. It can be argued that such a firm must have unique inputs that are specialized to its unique product—since product differentiation is otherwise compatible with perfect competition—and the uniqueness of these inputs allows them to earn positive rent, even in long-run equilibrium. The inclusion of rent in cost gives rise to the traditional Chamberlinian solution, in which (rent-inclusive) average cost is tangent to demand and therefore downward-sloping. But if rent is excluded, average cost may be constant or even upward-sloping in equilibrium, and in this sense, monopolistic competition need not give rise to excess capacity or to production facilities that are too small. The basic conclusion is that monopolistic competition improves welfare—that is to say, it creates consumer and producer surplus—by creating variety without necessarily reducing output.

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    Bibliographic Info

    Article provided by Eastern Economic Association in its journal Eastern Economic Journal.

    Volume (Year): 32 (2006)
    Issue (Month): 3 (Summer)
    Pages: 421-435

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    Handle: RePEc:eej:eeconj:v:32:y:2006:i:3:p:421-435

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    1. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
    2. Margolis, Stephen E, 1985. "The Excess Capacity Controversy: A Critique of Recent Criticism," Economic Inquiry, Western Economic Association International, vol. 23(2), pages 265-75, April.
    3. Rosen, Sherwin, 1974. "Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition," Journal of Political Economy, University of Chicago Press, vol. 82(1), pages 34-55, Jan.-Feb..
    4. Ohta, H, 1977. "On the Excess Capacity Controversy," Economic Inquiry, Western Economic Association International, vol. 15(2), pages 153-65, April.
    5. Barzel, Yoram, 1970. "Excess Capacity in Monopolistic Competition," Journal of Political Economy, University of Chicago Press, vol. 78(5), pages 1142-49, Sept.-Oct.
    6. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
    7. Schmalensee, Richard, 1972. "A Note on Monopolistic Competition and Excess Capacity," Journal of Political Economy, University of Chicago Press, vol. 80(3), pages 586-91, May-June.
    8. Murphy, Michael M, 1978. "The Consistency of Perfect and Monopolistic Competition," Economic Inquiry, Western Economic Association International, vol. 16(1), pages 108-12, January.
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