City size and the Henry George theoremunder monopolistic competition

We analyze the equilibrium and the optimal resource allocations in a monocentric city undermonopolistic competition. Unlike the constant elasticity of substitution (CES) case, wherethe equilibrium markups are independent of the city size, we present a variable elasticity ofsubstitution (VES) case where the equilibrium markups fall with the city size. We thenshow that, due to excess entry triggered by such pro-competitive effects, the 'golden rule' oflocal public finance, i.e., the Henry George theorem (HGT), does not hold in the secondbest. We finally prove, within our framework, that the HGT holds in the second best if andonly if: (i) the second-best allocation is first-best efficient, which turns out to be equivalentto the CES case; or (ii) a marginal change in the city size has no impact on equilibriumproduct diversity at the second best....