Product market

Sociology

Inefficiency

Monopolistic competition

Biology

Welfare

Macroeconomics

Market structure

Economics

Microeconomics

Market power

Ecology

Anthropology

Productivity

Diversity (politics)

Incentive

Monopoly

Resource allocation

Market economy

Industrial organization

Competition (biology)

Journal of Political Economy

Empirical work has drawn attention to the high degree of productivity differences within industries and their role in resource allocation. This paper examines the allocational efficiency of such markets. Productivity differences introduce two new margins of potential inefficiency: selection of the right distribution of firms and allocation of the right quantities across firms. We show that these considerations affect welfare and policy analysis, and market power across firms leads to distortions in resource allocation. Demand-side elasticities determine how resources are misallocated and when increased competition from market expansion provides welfare gains.

Monopolistic Competition and Optimum Product Diversity under Firm Heterogeneity