Monopolistic Competition: Beyond the CES∗ Evgeny Zhelobodko† Sergey Kokovin‡

Mathieu Parenti§Jacques-François Thisse¶

January 31, 2011

Abstract We propose a general model of monopolistic competition and derive a complete characterization of the market equilibrium using the concept of Relative Love for Variety. When the RLV increases with individual consumption, the market generates pro-competitive effects. When it decreases, the market mimics anti-competitive behavior. The CES is a borderline case. We extend our setting to heterogeneous firms and show that the cutoff cost decreases (increases) when the RLV increases (decreases). Last, we study how combining vertical, horizontal and cost heterogeneity affects our results.

Keywords: monopolistic competition, additive preferences, love for variety, heterogeneous firms. JEL Classification: D43, F12 and L13.

∗ We are grateful to S. Anderson, K. Behrens, E. Dinopoulos, R. Ericson, A. Gorn, J. Hamilton, E. Helpman, J. Martin, G. Mion, T. Holmes, F. Mayneris, P. Picard, V. Polterovich, R. Romano, O. Shepotilo, O. Skiba, D. Tarr, M. Turner, X. Vives, S. Weber, D. Weinstein, and H. Yildirim for comments and suggestions. We gratefully acknowledge the financial support from CORE, the Fonds de la Recherche Scientifique (Belgium), and the Economics Education and Research Consortium (EERC) under the grant No 08-036 (with the cooperation of the Eurasia Foundation, USAID, the World Bank, GDN, and the Government of Sweden). † Novosibirsk State University (Russia). Email: [email protected] ‡ Novosibirsk State University and Sobolev Institute of Mathematics (Russia). Email: [email protected] § Université de Paris 1 and PSE (France). Email: [email protected] ¶ CORE-UCLouvain (Belgium), Université du Luxembourg and CEPR. Email: [email protected]

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