Input-output linkages and optimal product diversity

- We study the role of technological side for welfare effects.
- IO linkages could reduce excess entry in equilibrium with pro-competitive effects.
- The CES case is not the border line between excess and insufficient entry.
- The equilibrium with pro-competitive effects may deliver excess or insufficient entry.

We derive a simple necessary and sufficient condition on preferences for the market outcome to be socially optimal under monopolistic competition with input-output (IO) linkages. Preferences that satisfy this condition are typically non-CES and display pro-competitive effects, although they converge to the CES when IO linkages become negligibly weak. We show that the equilibrium with pro-competitive effects may deliver both excess and insufficient entry of firms in equilibrium.