A Simple Extension to the Dixit-Stiglitz Framework to Allow for Strategic Interaction

This paper considers a simple extension to the Dixit-Stiglitz framework to allow for strategic interaction. We show that the markup under Bertrand competition is strictly lower than that under Cournot competition and is strictly higher than that under monopolistic competition. We also show that there are two opposing forces: the love for variety and price distortion. Under monopolistic competition, these forces offset one another, and the equilibrium is the second-best optimum. Under oligopolistic competition, price distortion dominates and, because of a lower markup, the social welfare under Bertrand competition is strictly higher than that under Cournot competition.