Monopolistic Competition and Optimum Product Diversity under Firm Heterogeneity

Economics

Speaker:Swati Dhingra, LSE
Date: Friday 28 September 2012
Time: 16.15
Location: Matrix Lecture Theatre, Building One

Further details

A fundamental question in theories of imperfect competition is whether the market allocates resources efficiently. We generalize the Spence-Dixit-Stiglitz framework to heterogeneous firms, addressing when the market provides optimal quantities, variety and productivity. This approach yields several insights about allocational efficiency under firm heterogeneity. First, constant elasticity of substitution (CES) demand ensures market allocations are efficient, despite differences in firm productivity. Second, when demand elasticities vary, market allocations are not efficient and reflect the distortions of imperfect competition. These distortions are not uniform within a market: some firms over produce while others under produce, and the pattern is determined by two demand side elasticities. Third, market imperfections derive from insufficient competition. Integration with large markets can achieve allocational efficiency in the absence of domestic policy.