Industry equilibrium and welfare in monopolistic competition under uncertainty

This paper offers a new theory that describes the influence of uncertainty on economic fundamentals. This theory posits that uncertainty can improve social welfare. We argue that in an economy, where spending of the customers for the differentiated good correlates with larger substitutability of its varieties, the equilibrium output decreases and the prices increase when uncertainty appears. Alternatively, if such spending and substitutability anti-correlate, the predictions for the price and output changes are reversed. The arguments are based on general equilibrium modeling with the monopolistic competition of firms which produce varieties of the differentiated good under limited information regarding the consumer demand. The impact of uncertainty on the equilibrium is assessed by using the relationship between the weighted elasticity of substitution between varieties, the elasticity of the consumer utility, and the income share spent on the differentiated good.