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Monopolistic Competition and Optimum Product Selection: Why and how heterogeneity matters

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  • Nocco, Antonella
  • Ottaviano, Gianmarco
  • Salto, Matteo

Abstract

After some decades of relative oblivion, the interest in the optimality properties of monopolistic competition has recently re-emerged due to the availability of an appropriate and parsimonious framework to deal with firm heterogeneity. Within this framework we show that non-separable utility, variable demand elasticity and endogenous firm heterogeneity cause the market equilibrium to err in many ways, concerning the number of products, the size and the choice of producers, the overall size of the monopolistically competitive sector. More crucially with respect to the existing literature, we also show that the extent of the errors depends on the degree of firm heterogeneity. In particular, the inefficiency of the market equilibrium seems to be largest when selection among heterogenous firms is needed most, that is, when there are relatively many firms with low productivity and relatively few firms with high productivity.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9417.

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Date of creation: Apr 2013
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Handle: RePEc:cpr:ceprdp:9417

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Keywords: heterogeneity; monopolistic competition; product diversity; selection; welfare;

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  1. Marc J. Melitz & Gianmarco I.P. Ottaviano, 2005. "Market Size, Trade, and Productivity," Development Working Papers 201, Centro Studi Luca d\'Agliano, University of Milano.
  2. OTTAVIANO, Gianmarco & THISSE, Jacques-François, 1999. "Agglomeration and trade revisited," CORE Discussion Papers 1999041, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  8. Arnaud Costinot & Andres Rodriguez-Clare & Costas Arkolakis, 2010. "New Trade Models, Same Old Gains?," 2010 Meeting Papers 433, Society for Economic Dynamics.
  9. Kristian Behrens & Yasusada Murata, 2009. "Trade, Competition, and Efficiency," Cahiers de recherche 0940, CIRPEE.
  10. Carole Maignan & Gianmarco Ottaviano & Dino Pinelli & Francesco Rullani, 2003. "Bio-Ecological Diversity vs. Socio-Economic Diversity: A Comparison of Existing Measures," Working Papers 2003.13, Fondazione Eni Enrico Mattei.
  11. Behrens, Kristian & Murata, Yasusada, 2007. "General equilibrium models of monopolistic competition: A new approach," Journal of Economic Theory, Elsevier, vol. 136(1), pages 776-787, September.
  12. 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.
  13. Kokovin, Sergey & Thisse, Jacques-François & Zhelobodko, Evgeny, 2010. "Monopolistic Competition: Beyond the CES," CEPR Discussion Papers 7947, C.E.P.R. Discussion Papers.
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