Monopolistic Competition and Efficiency under Firm Heterogeneity and Nonadditive Preferences

We consider the single-sector version of the Melitz-Ottaviano model of monopolistic competition with heterogeneous firms. We characterize the first-best and market allocations. We find that the market provides the first-best level of entry but too little selection; hence, the market provides too many varieties and too little aggregate quantity, and allocates too little (much) production to low (high) cost realizations. Allowing for a broad family of quantity allocation functions, we establish sufficient conditions for the global optimality of the first-best solution. Several important extensions are also examined. (JEL D21, D43, D50, D60)