Input–output linkages and optimal product diversity

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.