Monopolistic competition and optimum product diversity: Comment

Abstract

The model of Avinash Dixit and Joseph E. Stiglitz (1977) (DS hereafter) has received more and more attention from economists in the past decade and can now be regarded as the central model of monopolistic competition. Applications of the model can be found in such diverse fields as international trade, growth theory, and macroeconomics.1 The purpose of this short note is twofold. First, we suggest an alternative solution method to that proposed by DS and used in most applications of their model. Our method makes full use of the symmetry assumption employed by DS but extends their method, so that the resultant pricing rule takes into account the price-index effect. Our method retains the intuitive appeal and simplicity of the original DS model. Second, we show that our solution method extends the range of applicability of the DS model significantly; more general production structures can now be incorporated in the model. The note is organized as follows. In Section I we set up the DS model and develop our solution method. We also discuss the impact that the alternative solution method has on the qualitative results obtained in the DS study and the early application by Paul R. Krugman (1980). Section II broadens the scope of the discussion somewhat by discussing existence problems associated with the DS approach under increasing returns and isoelastic cost functions. It is shown that if our solution method is used then the existence problems disappear, and the DS model yields well-defined answers. Finally, in Section III some concluding remarks are given.

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