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Monopolistic Competition and Optimum Product Diversity: Reply

Stiglitz, Joseph E.; Dixit, Avinash K.

In the article, authors present a reply to the work of economists, Xiaokai Yang and Ben J. Heijdra, which commented on economic model on monopolistic competition. Authors state that their model on monopolistic competition and product diversity was intended for the large-group case. The underlying monopolistically competitive equilibrium of a symmetric group is governed by two conditions. Firstly, each firm's maximization equates marginal revenue and marginal cost. Secondly, free entry equates average revenue and average cost. Authors state that Yang and Heijdra destroy their own criticism when they assume that cross elasticities are negligible. Authors agree that the equilibrium based on their approximation needs a constant ratio of average and marginal utilities which is possible with the help of a constant elasticity of demand. However, Yang and Heijdra's modification can only shift the equilibrium in a small way when the number of products is large. The cost function in the model given by authors had a fixed component with constant marginal cost, thus the problem of inconsistency among cost of production and the demand relation in equilibrium does not arise.

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American Economic Review

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Economics
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April 22, 2013