| Sumario: | In their article "Monopolistic Competition and Optimum Product Diversity," economists Avinash Dixit and Joseph Stiglitz studied whether under monopolistic competition there will be too many or too few products. They conclude that if the demand for each individual product in the industry is of constant elasticity, then the monopolistic competition equilibrium will have the optimum number of products, given the constraint that each firm must at least break even. Then they go on to study the case of variable-elasticity product demand curves. They conclude that there is no necessary relation between the elasticity of the product demand curves and optimum product diversity. But, they conclude that for an important family of utility functions, if the elasticity of demand falls as the scale of output in each firm rises, then monopolistic competition will lead to fewer than the optimal number of firms/products. This result is false. In fact, it is fairly easy to show that, within their model, if the elasticity of demand for an individual firm's product falls as the scale of output increases, then monopolistic competition will lead to too many products. Under Dixit and Stiglitz's framework, each consumer consumes a small proportion of each product on the market. It is hard to think of any market where this is a plausible assumption.
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