Consumer Prices Decrease in Densely Populated Areas

HSE University economists have proposed a novel approach to modelling monopolistic competition with heterogeneous firms and consumers. It addresses the shortcomings of the traditional model and takes into account the diverse preferences of consumers. The results of collaborative research carried out by Alexander Tarasov from Moscow, his co-authors from HSE University–St Petersburg, together with the Norwegian School of Economics, the University of Pennsylvania, and the Free University of Brussels, have been published in American Economic Journal: Microeconomics, one of the most prestigious journals of the American Economic Association.

The model of monopolistic competition has been a key tool in micro- and macroeconomics, international trade research, and many other fields since the 1970s. It assumes that there are numerous sellers in the market offering similar products with different properties. Sellers compete with each other, while the standard model does not consider consumer preferences. The authors attempted to improve this theory by incorporating differences in consumer demand, considering geographic aspects, product preferences, and ‘popularity.’ With these innovations, firms face a choice: either compete with a large number of firms in a popular niche or sell a less popular product under looser conditions. The authors described it as follows: ‘foxes’ (firms) want to hunt as many ‘chickens’ (consumers) as possible while avoiding encounters with ‘hunters’ (strong competitors).

After constructing the model, the authors tested it on data from Norwegian hair salons, studying the competition among 116 salons in the city of Bergen. The results showed that more productive firms choose more popular niches. Additionally, in more densely populated areas, the equilibrium price decreases. Consumers living closer to the city centre benefit more than residents of remote areas.