Monopolistic Competition under Horizontal and Vertical Differentiation

Sergey Kichko, Marco Marini, Ricardo Saulle and Thisse, Jacques-François

No 21305, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper extends the CES model of monopolistic competition to the case where varieties are both horizontally and vertically differentiated. A distinctive feature of our model is the presence of a network externality, which operates through the number of varieties available at each quality level. Depending on the quality gap, there are corner equilibria in which consumers purchase only high-quality or low-quality varieties, or an interior equilibrium in which consumers are split between the two qualities. Unlike the CES model of monopolistic competition, the equilibrium is never efficient and the market may even select the outcome with the lowest surplus.

Keywords: Monopolistic competition; Vertical differentiation; Horizontal differentiation (search for similar items in EconPapers)
JEL-codes: D42 D43 L1 L12 L13 L41 (search for similar items in EconPapers)
Date: 2026-03
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