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Monopolistic Competition and Optimal Product Diversity with Heterogeneous Firms


  • Lugovskyy, Volodymry


I extend the Dixit-Stiglitz (1977) model of monopolistic competition by relaxing the assumption of a single technology. The main objective is to study whether the equivalence of the monopolistically competitive equilibrium to the social optimum still holds in the extended model. I show that the answer crucially depends on the nature of the technological heterogeneity. If firms are free to choose technology, and free entry/exit condition holds to ensure a zero profit equilibrium, then the Dixit-Stiglitz result is robust to the existence of heterogeneous firms. However, if firm-level productivity is drawn from a heterogeneous distribution so that some infra-marginal firms earn positive profits then the market equilibrium no longer has the same desirable properties.

Suggested Citation

  • Lugovskyy, Volodymry, 2003. "Monopolistic Competition and Optimal Product Diversity with Heterogeneous Firms," Purdue University Economics Working Papers 1163, Purdue University, Department of Economics.
  • Handle: RePEc:pur:prukra:1163

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    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance


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