Competition and Product Variety

Three results of the study which are of general interest are the following: 1. It is never optimal to produce any good at minimum average cost, but always better to increase variety at the expense of average cost when any good reaches this level of output. 2. A structure very similar to that of Chamberlin's monopolistic competition is the "most perfect" market structure that can be generated, being the Nash equilibrium of firms under conditions of perfect information, noncollusion, perfect flexibility, and free and willing entry. Thus, this structure cannot be regarded as "imperfect competition"' and is here referred to as "perfect monopolistic competition." The traditional "perfect competition" structure cannot exist under the conditions posited for the This paper is an analysis of the economic consequences of infinitely variable product specification in the presence of diverse consumer preferences and some minimal degree of economies of scale near the origin and thus might be considered a study of the contemporary high-technology economy. The study covers both the welfare economics and the market structures associated with such an economy. The emphasis throughout is on the degree of product variety which is optimal (in the welfare economics sections) or will be generated by the market and on how the degree of variety differs between different market structures and between the market and the optimum. *The background analysis on which the results of this paper are based is set out in detail in Lancaster (1979), which was unpublished at the time of the original presentation of the paper. The author wishes to acknowledge the assistance of the National Science Foundation, grant SOC 75-14252. A preliminary version of the analysis, given in Lancaster (1975), reaches some incorrect conclusions concerning the properties of market equilibria because it did not include provision for "outside goods" (goods outside the product class being considered) without which there are no stable market equilibria. 1. In this sense Chamberlin was correct in asserting that monopolistic competition was not a form of imperfect competition. Since he was not able to handle the analysis of variable product differentiation, he was not able to show that the monopolistic competition structure was inherent in certain types of situation.