Working Paper: CEPR ID: DP9417
Authors: Antonella Nocco; Gianmarco Ottaviano; Matteo Salto
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.
Keywords: heterogeneity; monopolistic competition; product diversity; selection; welfare
JEL Codes: D4; D6; F1; L0; L1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm heterogeneity (D21) | market equilibrium inefficiency (D59) |
| number of products (C69) | market equilibrium inefficiency (D59) |
| size of producers (D20) | market equilibrium inefficiency (D59) |
| overall size of monopolistically competitive sector (L11) | market equilibrium inefficiency (D59) |
| low-productivity firms and high-productivity firms (D22) | market equilibrium inefficiency (D59) |
| errors in market outcomes (D43) | average productivity (O49) |
| errors in market outcomes (D43) | average firm size (L25) |
| market heterogeneity (D40) | errors in market outcomes (D43) |