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Essay / Summary of the article “Monopolistic Competition and...
“Monopolistic Competition and Optimal Product Diversity” is a famous article by Avinash K. Dixit and Joseph E. Stiglitz published in the American Economic Review in 1977 . This article is selected as one of the 20 best articles published in the American Economic Review in 100 years. In this article, the authors address one of the important questions regarding production in welfare economics, namely the balance between quantity and diversity. If a society wants to be able to produce a variety of goods and services, then it must sacrifice gains from economies of scale. Thus, producing less variety for a greater quantity will save resources at the cost of some loss of well-being. Many studies attempt to model this trade-off using an indirect approach. The results of these studies hardly address the main question and are often difficult to interpret. Thus, the authors choose a direct approach by observing that the convexity of indifference curves takes into account the opportunity for variety. The authors observe that there are different groups of goods. A good of a certain group is a close substitute for other goods of the same group, but a weak substitute for goods of a different group. The authors then adopt a convex utility function separable into a group of goods and the rest of the economy. Based on these observations, the author focuses on two cases; in one case, they take the CES form for the utility function of a group of goods and the general form for the overall utility function to show the inter-group relationship, and in the other case, they take the Cobb-Douglas form for the overall utility function and The utility function of a group of goods is in an arbitrary form to explain the relationship between the goods of a certain group. The authors neglect the impact of resources, they believe that monopoly power actually allows the firm to survive and that the relationship between monopoly power and market distortion is unclear. They mention that when elasticities are constant, the market equilibrium and the constrained Pareto optimum are the same. But with varying elasticities, the results of market equilibrium are not the same as those of the constrained Pareto optimum. There is therefore a market distortion if the elasticities vary, and the direction of the distortion depends on the elasticity of utility. Under the asymmetry, the authors point out that there is a bias against goods with inelastic demand and high costs. This is another type of market distortion. The authors end their article by pointing out that the results of market equilibrium and social optimum could be different due to different objectives evident in various cases, as discussed in the article..