Theory Seminar

Swati Dhingra

London Schoolf of Economics

26-Nov-2012

Seminar 3 – 13:30

Abstract

The misallocation of resources is endemic to imperfect competition. We generalize the Spence-Dixit-Stiglitz framework to heterogeneous firms, addressing when the market provides optimal quantities, variety and productivity. This yields several insights. First, constant elasticity of substitution demand ensures market allocations are efficient, despite differences in firm productivity. Second, when demand elasticity varies, allocations reflect the distortions of imperfect competition. Firm heterogeneity matters for distortions: some firms over-produce while others underproduce, and the pattern of misallocation is determined by two demand-side elasticities. Third, market imperfections derive from insufficient competition. We show market expansion increases welfare when private and social incentives are aligned, and efficiency is obtained in large markets.

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