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Investment, Externalities & Industry Dynamics

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  • Santanu Roy
  • Takashi Kamihigashi

Abstract

We provide an alternative theoretical explanation for a number of empirical regularities relating to the dynamics of industry structrure (product life cycle) and changes in size and age distribution of firms over time. We explain why entry may continue over a considerable period of time, why shake out of firms occur in mature industries and why exiting firms are likely to be younger and smaller in size than incumbents. Unlike the existing theoretical literature, this explanation is not based on uncertainty, structural non-stationarity or incomplete information. We consider an infinite horizon, complete information, deterministic competitive industry with continuum of firms and stationary market demand. Firms have perfect foresight, may enter or exit the industry at any point of time and active firms undertake investment which reduces their future cost of production. Investment by active firms also leads to the growth of an industry-wide capital that reduces production cost of all firms (externality). The marginal cost curves are upward sloping and firms incur a fixed cost of staying in the industry. While all entering firms earn zero intertemporal net profit, their instantaneous net profit is typically negative when they are young and strictly positive when they mature. Positive profits may persist in the long run. Equilibrium prices decline over time while the level of positive industry-wide externality increases with time.The equilibrium path makes firms indifferent between alternative entry and exit decisions. Their investment levels after entry reflects their length of stay & the nature of industry environment (prices, externalities) over their period of stay in the industry. Heterogeneity emerges out of deliberate choice. The industry stabilizes in the long run

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 144.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:144

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Keywords: Industry Dynamics; Entry; Shake out; Cost Reducing Investment; Learning; Spillovers; Competitive Industry.;

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  1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  2. Steve J. Davis & John Haltiwanger, 1991. "Gross job creation, gross job destruction and employment reallocation," Working Paper Series, Macroeconomic Issues 91-5, Federal Reserve Bank of Chicago.
  3. Saul Lach & Rafael Rob, 1992. "R&D, Investment and Industry Dynamics," NBER Working Papers 4060, National Bureau of Economic Research, Inc.
  4. Gort, Michael & Klepper, Steven, 1982. "Time Paths in the Diffusion of Product Innovations," Economic Journal, Royal Economic Society, vol. 92(367), pages 630-53, September.
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  6. Ericson, Richard & Pakes, Ariel, 1995. "Markov-Perfect Industry Dynamics: A Framework for Empirical Work," Review of Economic Studies, Wiley Blackwell, vol. 62(1), pages 53-82, January.
  7. Petrakis, Emmanuel & Roy, Santanu, 1999. "Cost-Reducing Investment, Competition, and Industry Dynamics," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(2), pages 381-401, May.
  8. Lambson, V.E., 1989. "Industry Evolution With Sunk Costs And Uncertian Market Conditions," Working papers 8904, Wisconsin Madison - Social Systems.
  9. Jovanovic, Boyan & Lach, Saul, 1989. "Entry, Exit, and Diffusion with Learning by Doing," American Economic Review, American Economic Association, vol. 79(4), pages 690-99, September.
  10. Klepper, Steven, 1996. "Entry, Exit, Growth, and Innovation over the Product Life Cycle," American Economic Review, American Economic Association, vol. 86(3), pages 562-83, June.
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  13. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  14. Dasgupta, Partha & Stiglitz, Joseph, 1980. "Industrial Structure and the Nature of Innovative Activity," Economic Journal, Royal Economic Society, vol. 90(358), pages 266-93, June.
  15. Geroski, Paul A & Mazzucato, Mariana, 2000. "Modelling the Dynamics of Industry Populations," CEPR Discussion Papers 2650, C.E.P.R. Discussion Papers.
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  17. James Bergin & Dan Bernhardt, 2006. "Industry Dynamics with Stochastic Demand," Working Papers 1043, Queen's University, Department of Economics.
  18. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  19. Hopenhayn, Hugo A., 1992. "Exit, selection, and the value of firms," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 621-653.
  20. Spence, Michael, 1984. "Cost Reduction, Competition, and Industry Performance," Econometrica, Econometric Society, vol. 52(1), pages 101-21, January.
  21. Hugo A. Hopenhayn, 1993. "The shakeout," Economics Working Papers 33, Department of Economics and Business, Universitat Pompeu Fabra.
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Cited by:
  1. James Prieger, 2007. "The Impact of Cost Changes on Industry Entry and Exit," Journal of Economics, Springer, vol. 91(3), pages 211-243, July.

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