Summary of the paper 'Monopolistic Competition and Optimum Product Diversity'

'Monopolistic Competition and Optimum Product Diversity' is a famous paper written by Avinash K. Dixit and Joseph E. Stiglitz published in American Economic Review in 1977. This paper is selected as one of the top 20 articles published in American Economic Review in 100 years. In this paper the authors address one of the important issues regarding production in welfare economics that is the balance between quantity and diversity. If any society wants to have variety of goods and services to be produced, then it has to sacrifice the gain due to scale economics. Thus, producing less variety of greater quantity will save the resources at the cost of some welfare loss. Many studies attempt to model this trade off using the indirect approach. The results of these studies hardly addressed the main issue and often difficult to interpret. So, the authors choose a direct approach by observing that the convexity of the indifference curves takes into account the desirability of variety.

The authors observe that there are different groups of goods. A good in a certain group is close substitute for other goods in the same group but weak substitute with the goods in different group. The authors then take a convex utility function separable in one group of goods and the rest of the economy. Based on these observations the author focus on two cases; in one case they take the CES form for the utility function of a group of goods and general form for the overall utility function to show the inter-group relationship, and in other case they take the Cobb-Douglas form for the overall utility function and utility function of a group of goods is in arbitrary form to explain the connection among the goods in a certain group. The authors neglect the imp...

... middle of paper ...

... of resources, they opine that the monopoly power in fact enables firm to survive and the relationship between monopoly power and market distortion is not clear. They mention that when elasticities are constant the market equilibrium and constrained Pareto optimal are same. But with variable elasticities the results of market equilibrium are not same as constrained Pareto optimal. So, there is market distortion if the elasticities vary, and the direction of distortion depends on the elasticity of utility. Under the asymmetry the authors point out that there is bias against goods with inelastic demand and high costs. This is another type of market distortion. The authors finish their paper by emphasizing that the results of the market equilibrium and social optimum could be different due to different objectives that evident in various cases as discussed in the paper.