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Monopolistic Competition and Optimum Product Selection: Why and How Heterogeneity Matters

  • Antonella Nocco
  • Gianmarco I. P. Ottaviano
  • Matteo Salto

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 heterogeneous 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 Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1206.

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Date of creation: Apr 2013
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Handle: RePEc:cep:cepdps:dp1206
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Bagnoli, M. & Bergstrom, T., 1989. "Log-Concave Probability And Its Applications," Papers 89-23, Michigan - Center for Research on Economic & Social Theory.
  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).
  3. Marc J. Melitz & Stephen J. Redding, 2013. "Firm Heterogeneity and Aggregate Welfare," CEP Discussion Papers dp1200, Centre for Economic Performance, LSE.
  4. Kristian Behrens & Yasusada Murata, 2009. "Trade, Competition, and Efficiency," Cahiers de recherche 0940, CIRPEE.
  5. 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.
  6. Kokovin, Sergey & Thisse, Jacques-François & Zhelobodko, Evgeny, 2010. "Monopolistic Competition: Beyond the CES," CEPR Discussion Papers 7947, C.E.P.R. Discussion Papers.
  7. Marc J. Melitz & Stephen J. Redding, 2012. "Heterogeneous Firms and Trade," NBER Working Papers 18652, National Bureau of Economic Research, Inc.
  8. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  9. Marc J. Melitz & Stephen J. Redding, 2013. "New Trade Models, New Welfare Implications," NBER Working Papers 18919, National Bureau of Economic Research, Inc.
  10. Costas Arkolakis & Arnaud Costinot & Andres Rodriguez-Clare, 2012. "New Trade Models, Same Old Gains?," American Economic Review, American Economic Association, vol. 102(1), pages 94-130, February.
  11. 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.
  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. 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.
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