Excess Capacity in Monopolistic Competition
Posted: 30 Aug 2012
Date Written: 1970
We should first note that if one does not view expenditures on quality, location, or promotion as utility-generating expenditures, misallocation occurs by definition. We will follow Demsetz, however, in proposing that such expenditures, including those on promotion, do in fact generate utility. We want to show that when price and quantity are appropriately measured, contrary to Demsetz's argument, average cost necessarily falls at equilibrium. We will proceed by first showing that for quality-improving costs, if the quantity-price locus has a zero slope at equilibrium the slope is negative at equilibrium for quality-adjusted units. The argument will be extended to cover other types of cost, and it will be shown that regardless of the slope of the quantity-price locus at equilibrium, the slope of the properly measured average cost curve has to be negative.
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