NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Monopoly Power and Endogenous Product Variety: Distortions and Remedies

Florin O. Bilbiie, Fabio Ghironi, Marc J. Melitz

NBER Working Paper No. 14383
Issued in October 2008
NBER Program(s):   EFG

The inefficiencies related to endogenous product creation and variety under monopolistic competition are two-fold: one static—the misalignment between consumers and producers regarding the value of a new variety; and one dynamic—time variation in markups. Quantitatively, the welfare costs of the former are potentially very large relative to the latter. For a calibrated version of our model with these distortions, their total cost amounts to 2 percent of consumption. Appropriate taxation schemes can implement the optimum amount of entry and variety. Elastic labor introduces a further distortion that should be corrected by subsidizing labor at a rate equal to the markup for goods, in order to preserve profit margins and hence entry incentives.

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This paper was revised on June 1, 2016

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Document Object Identifier (DOI): 10.3386/w14383

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