Markov perfect industry dynamics with many firms

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Markov perfect industry dynamics with many firms

Author Info

Gabriel Y. Weintraub
C. Lanier Benkard
Benjamin Van Roy

Abstract

We propose an approximation method for analyzing Ericson and Pakes (1995)-style dynamic models of imperfect competition. We develop a simple algorithm for computing an "oblivious equilibrium," in which each firm is assumed to make decisions based only on its own state and knowledge of the long run average industry state, but where firms ignore current information about competitors' states. We prove that, as the market becomes large, if the equilibrium distribution of firm states obeys a certain "lighttail" condition, then oblivious equilibria closely approximate Markov perfect equilibria. We develop bounds that can be computed to assess the accuracy of the approximation for any given applied problem. Through computational experiments, we find that the method often generates useful approximations for industries with hundreds of firms and in some cases even tens of firms.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2005-23.

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Date of creation: 2005
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Handle: RePEc:fip:fedfwp:2005-23

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Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Computational Methods for Oblivious Equilibrium," Research Papers 1969, Stanford University, Graduate School of Business. [Downloadable!]

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