City size and the Henry George theorem under monopolistic competition

We analyze the equilibrium and the optimal resource allocations in a monocentric city under monopolistic competition. Unlike the constant elasticity of substitution (CES) case, where the equilibrium markups are independent of city size, we present a variable elasticity of substitution (VES) case where the equilibrium markups fall with city size. We then show that, due to excess entry triggered by such pro-competitive effects, the ‛golden rule’ of local public finance, i.e., the Henry George Theorem (HGT) , does not hold at the second best. We finally prove, within a more general framework, that the HGT holds at the second best under monopolistic competition if and only if the secondbest allocation is first-best efficient, which reduces to the CES case.