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Quantifying the Gap Between Equilibrium and Optimum under Monopolistic Competition

Author

Listed:
  • Kristian Behrens
  • Giordano Mion
  • Yasusada Murata
  • Jens Suedekum

Abstract

Equilibria and optima generally differ in imperfectly competitive markets. Although this is well understood theoretically, it is unclear how large the welfare distortions are in the aggregate economy. Do they matter quantitatively? To answer this question, we develop a multisector monopolistic competition model with endogenous firm entry and selection, productivity, and markups. Using French and UK data, we quantify the gap between the equilibrium and optimal allocations. We find that inefficiencies in the labor allocation and entry between sectors, as well as inefficient selection and output per firm within sectors, generate welfare losses of about 6%–10% of GDP.

Suggested Citation

  • Kristian Behrens & Giordano Mion & Yasusada Murata & Jens Suedekum, 2020. "Quantifying the Gap Between Equilibrium and Optimum under Monopolistic Competition," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 135(4), pages 2299-2360.
    • Handle: RePEc:oup:qjecon:v:135:y:2020:i:4:p:2299-2360.
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    File URL: http://hdl.handle.net/10.1093/qje/qjaa017
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    Cited by:

    1. Egger, Peter H. & Huang, Ruobing, 2025. "Market versus optimum allocation in open economies," Journal of Economic Theory, Elsevier, vol. 228(C).
    2. Macedoni, Luca & Weinberger, Ariel, 2022. "Quality heterogeneity and misallocation: The welfare benefits of raising your standards," Journal of International Economics, Elsevier, vol. 134(C).
    3. Alexander Tarasov & Robertas Zubrickas, 2023. "Optimal income taxation under monopolistic competition," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(2), pages 495-523, August.
    4. Sophie Osotimehin & Latchezar Popov, 2023. "Misallocation and Intersectoral linkages," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 177-198, December.
    5. David Rezza Baqaee & Emmanuel Farhi & Kunal Sangani, 2024. "The Darwinian Returns to Scale," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 91(3), pages 1373-1405.
    6. Kokovin, Sergey & Molchanov, Pavel & Bykadorov, Igor, 2022. "Increasing returns, monopolistic competition, and international trade: Revisiting gains from trade," Journal of International Economics, Elsevier, vol. 137(C).
    7. Ziran Ding, 2021. "Optimal Tariffs with Firm Heterogeneity, Variable Markups, and FDI," Bank of Lithuania Working Paper Series 99, Bank of Lithuania.
    8. Marco de Pinto & Laszlo Goerke, 2022. "Cost uncertainty in an oligopoly with endogenous entry," Bulletin of Economic Research, Wiley Blackwell, vol. 74(4), pages 927-948, October.
    9. Jung, Benjamin & Kohler, Wilhelm, 2021. "Input-output linkages and monopolistic competition: Input distortion and optimal policies," Hohenheim Discussion Papers in Business, Economics and Social Sciences 06-2021, University of Hohenheim, Faculty of Business, Economics and Social Sciences.
    10. Matsuyama, Kiminori & Ushchev, Philip, 2022. "Selection and Sorting of Heterogeneous Firms through Competitive Pressures," CEPR Discussion Papers 17092, C.E.P.R. Discussion Papers.
    11. Brian C. Albrecht & Tom Phelan & Nick Pretnar, 2023. "Time Use and the Efficiency of Heterogeneous Markups," Working Papers 23-28, Federal Reserve Bank of Cleveland.
    12. Weinberger, Ariel, 2020. "Markups and misallocation with evidence from exchange rate shocks," Journal of Development Economics, Elsevier, vol. 146(C).
    13. Rui Pan & Dao‐Zhi Zeng, 2024. "Goods market desirability of minimum wages," Economica, London School of Economics and Political Science, vol. 91(364), pages 1255-1290, October.
    14. Hiroki Aizawa & Tatsuhito Kono, 2025. "How Should Place‐Based Policies Be Designed to Efficiently Promote Retail Agglomeration?," Journal of Regional Science, Wiley Blackwell, vol. 65(5), pages 1423-1448, November.
    15. Kristian Behrens & Sergei Kichko & Philip Ushchev, 2024. "ε‐ces preferences and trade," Review of International Economics, Wiley Blackwell, vol. 32(4), pages 1567-1586, September.
    16. Siying Ding & Ahmad Lashkaripour & Volodymyr Lugovskyy, 2024. "A Global Perspective on the Incidence of Monopoly Distortions," CESifo Working Paper Series 11211, CESifo.
    17. Issam Samiri & Yunus Aksoy & Arup Daripa, 2024. "Firm Ownership and the Macroeconomics of Incentive Leakages," National Institute of Economic and Social Research (NIESR) Discussion Papers 563, National Institute of Economic and Social Research.
    18. Kefu Lin & Rui Pan & Dao-Zhi Zeng, 2024. "Carbon tax vs. emission trading in a monopolistically competitive market with heterogeneous firms," The Annals of Regional Science, Springer;Western Regional Science Association, vol. 73(2), pages 825-848, August.
    19. Georg Schneider & Frank Stähler & Georg U. Thunecke, 2022. "The (Non-)Neutrality of Value-Added Taxation," CESifo Working Paper Series 9663, CESifo.
    20. Emmanuel Dhyne & Ayumu Ken Kikkawa & Glenn Magerman, 2022. "Imperfect Competition in Firm-to-Firm Trade," Journal of the European Economic Association, European Economic Association, vol. 20(5), pages 1933-1970.
    21. Kushnir, Alexey & Tarasov, Alexander & Zubrickas, Robertas, 2021. "On equilibrium in monopolistic competition with endogenous labor," Economics Letters, Elsevier, vol. 201(C).
    22. Dao‐Zhi Zeng & Shin‐Kun Peng, 2021. "Symmetric tax competition and welfare with footloose capital," Journal of Regional Science, Wiley Blackwell, vol. 61(2), pages 472-491, March.
    23. Tadokoro, Atsushi, 2024. "Optimal policy against distortions caused by monopolistic competition and variable markup pricing," Economics Letters, Elsevier, vol. 237(C).
    24. Monika Mrázová & J. Peter Neary & Mathieu Parenti, 2021. "Sales and Markup Dispersion: Theory and Empirics," Econometrica, Econometric Society, vol. 89(4), pages 1753-1788, July.
    25. Jung, Benjamin & Kohler, Wilhelm, 2020. "Input-Output Linkages and Monopolistic Competition: Input Distortion and Optimal Policies," VfS Annual Conference 2020 (Virtual Conference): Gender Economics 224608, Verein für Socialpolitik / German Economic Association.

    More about this item

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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