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Firm Heterogeneity, Endogenous Entry, and the Business Cycle

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  • Gianmarco I.P. Ottaviano

Abstract

This paper investigates the role that the entry and exit of heterogeneous firms plays in shaping aggregate fluctuations in economic activity. In so doing, it develops a dynamic stochastic general equilibrium model in which procyclical entry and countercyclical exit along a real business cycle lead to endogenous cyclical movements in average firm productivity. These movements stem from a composition effect due to the reallocation of market shares among firms with different levels of efficiency and affect the propagation of exogenous technological shocks. Numerical analysis suggests that existing models with representative firms may overstate the actual role of procyclical entry and exit in imperfectly competitive markets as a propagation mechanism of exogenous technology shocks. The reason is that procyclical entry and countercyclical exit disproportionately involve less efficiency firms whose impact on aggregate economic activity is hampered by their smaller size.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17433.

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Date of creation: Sep 2011
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Publication status: published as Gianmarco I. P. Ottaviano, 2012. "Firm Heterogeneity, Endogenous Entry, and the Business Cycle," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 8(1), pages 57 - 86.
Handle: RePEc:nbr:nberwo:17433

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  1. J Peter Neary, 2004. "Cross-Border Mergers as Instruments of Comparative Advantage," Working Papers, School Of Economics, University College Dublin 200404, School Of Economics, University College Dublin.
  2. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  3. Steve J. Davis & John Haltiwanger, 1991. "Gross job creation, gross job destruction and employment reallocation," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago 91-5, Federal Reserve Bank of Chicago.
  4. Steven J. Davis & R. Jason Faberman & John Haltiwanger, 2006. "The Flow Approach to Labor Markets: New Data Sources and Micro-Macro Links," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 20(3), pages 3-26, Summer.
  5. Choi, E. Kwan & Harrigan, James, 2003. "Handbook of International Trade," Staff General Research Papers, Iowa State University, Department of Economics 11375, Iowa State University, Department of Economics.
  6. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2012. "Endogenous Entry, Product Variety, and Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 120(2), pages 304 - 345.
  7. Ghironi, Fabio & Melitz, Marc J, 2004. "International Trade and Macroeconomic Dynamics with Heteroegenous Firms," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4595, C.E.P.R. Discussion Papers.
  8. Ottaviano, Gianmarco & Melitz, Marc, 2008. "Market Size, Trade, and Productivity," Scholarly Articles 3229096, Harvard University Department of Economics.
  9. Andrew B. Bernard & J. Bradford Jensen & Stephen Redding & Peter K. Schott, 2007. "Firms in International Trade," CEP Discussion Papers, Centre for Economic Performance, LSE dp0795, Centre for Economic Performance, LSE.
  10. Christian Broda & David E. Weinstein, 2010. "Product Creation and Destruction: Evidence and Price Implications," American Economic Review, American Economic Association, American Economic Association, vol. 100(3), pages 691-723, June.
  11. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers, Centre for Economic Performance, LSE dp0110, Centre for Economic Performance, LSE.
  12. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(7), pages 1238-1252, October.
  13. Gali Jordi, 1994. "Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand," Journal of Economic Theory, Elsevier, Elsevier, vol. 63(1), pages 73-96, June.
  14. Steven J. Davis & John Haltiwanger, 1990. "Gross Job Creation and Destruction: Microeconomic Evidence and Macroeconomic Implications," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 123-186 National Bureau of Economic Research, Inc.
  15. Katharine G. Abraham & John C. Haltiwanger, 1995. "Real Wages and the Business Cycle," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 33(3), pages 1215-1264, September.
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Cited by:
  1. Sun, Churen & Tian, Guoqiang & Zhang, Tao, 2011. "When Pareto meets Melitz: the inapplicability of the Melitz-Pareto model for Chinese firms," MPRA Paper 35597, University Library of Munich, Germany.
  2. Sun, Churen & Zhang, Tao, 2012. "Export, Productivity Pattern, and Firm Size Distribution," MPRA Paper 36742, University Library of Munich, Germany.
  3. Gianmarco I. P. Ottaviano, 2012. "Agglomeration, Trade and Selection," CEP Discussion Papers, Centre for Economic Performance, LSE dp1129, Centre for Economic Performance, LSE.

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