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The Impact of Integration on Productivity and Welfare Distortions Under Monopolistic Competition

  • Swati Dhingra
  • John Morrow

A fundamental question in monopolistic competition theory is whether the market allocates resources efficiently. This paper generalizes the Spence-Dixit-Stiglitz framework to heterogeneous firms, addressing when the market provides optimal quantities, variety and productivity. Under constant elasticity demand, each firm prices above its average cost, yet we show market allocations are efficient. When demand elasticities vary, market allocations are not efficient and reflect the distortions of imperfect competition. After determining the nature of market distortions, we investigate how integration may serve as a remedy to imperfect competition. Both market distortions and the impact of integration depend on two demand side elasticities, and we suggest richer demand structures to pin down these elasticities. We also show that integration eliminates distortions, provided the post-integration market is sufficiently large.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1130.

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Date of creation: Feb 2012
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Handle: RePEc:cep:cepdps:dp1130
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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