Cascading Failures in Production Networks

This paper analyzes a general equilibrium economy featuring input-output connections, imperfect competition, and external economies of scale owing to entry and exit. The interaction of input-output networks with industry-level market structure affects the amplification of shocks and the pattern of diffusion in the model, generating cascades of firm entry and exit across the economy. In this model, sales provide a poor measure of the systemic importance of industries. Unlike the relevant notions of centrality in competitive constant-returns-to- scale models, systemic importance depends on the industry’s role as both a supplier and as a consumer of inputs, as well as the market structure of industries. A basic calibration of the model suggests that aggregate output is three times more volatile in response to labor productivity shocks when compared to a perfectly competitive model.