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  5. A Theory of Monopolistic Competition with Horizontally Heterogeneous Consumers

A Theory of Monopolistic Competition with Horizontally Heterogeneous Consumers

  • Sergey Kokovin
  • Alina Ozhegova
  • Shamil Sharapudinov
  • Alexander Tarasov
  • Philip Ushchev
American Economic Journal: Microeconomics (Forthcoming)

Abstract

Our novel approach to modeling monopolistic competition with heterogeneous firms and consumers involves spatial product differentiation. Space can be interpreted either as a geographical space or as a space of characteristics of a differentiated good. In addition to price setting, each firm also chooses its optimal location in this space. We formulate conditions for positive sorting: more productive firms serve larger market segments and face tougher competition; and for the existence and uniqueness of the equilibrium. To quantify the role of the sorting mechanism, we calibrate the model using cross-sectional haircut market data and perform counterfactual analysis. We find that inequality in the distribution of the gains among consumers caused by positive market shocks can be substantial: the gains of consumers from more populated locations are 3–4 times higher.

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