Discussion Paper Details

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

Author(s): Antonella Nocco, Gianmarco Ottaviano and Matteo Salto

Publication Date: April 2013

Keyword(s): heterogeneity, monopolistic competition, product diversity, selection and welfare

Programme Area(s): International Trade and Regional Economics

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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Bibliographic Reference

Nocco, A, Ottaviano, G and Salto, M. 2013. 'Monopolistic Competition and Optimum Product Selection: Why and how heterogeneity matters'. London, Centre for Economic Policy Research.