Substitutability, Cost Effectiveness, and Output (revised 23 April 2012; formerly titled “Product Change and Output Invariance” and then “Output Invariance Across Products”)

This note gives a method that can sometimes be used to find the long-run equilibrium output of a firm operating under imperfect competition and which differs from standard methods of output determination. Let X be a product supplied under oligopoly or monopolistic competition and suppose that, by changing certain properties of X, we arrive at a new product, Y, which is sold under perfect competition. For example, Y might be a generic version of a good or service, while X is a differentiated version. Under a basic assumption given in the paper, this firm’s equilibrium output of X will then be where the average cost of Y reaches its minimum. At the level of the firm, the equilibrium outputs of the two goods will be the same, in other words, as long as each product is viable. While this outcome is not consistent with a first-best welfare maximum, it does have a desirable welfare property.