Product design in monopolistic competition

Abstract

We consider a model of monopolistic competition where producers can manipulate an elasticity parameter at an early stage. We interpret this as a choice of product specialization. Lower marginal costs of production lead to more generic products in all equilibria, which lead to fewer varieties under free‐entry. Entry of a new firm increases overall specialization and increases prices, that is, the environment exhibits price‐increasing competition. The loss of consumer surplus due to higher prices and lower consumption is compensated by the value of additional variety, hence entry also increases consumer surplus. Therefore, price‐increasing competition need not be anticompetitive under endogenous specialization.