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Industry Dynamics with Stochastic Demand

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  • James Bergin

    (Queen's University)

  • Dan Bernhardt

    (University of Illinois)

Abstract

We study the dynamics of an industry subject to aggregate demand shocks where the productivity of a firm's technology evolves stochastically over time. Each period, each firm, given the aggregate demand shock, the productivity of its technology, and the distribution of technology productivities in the economy, (i) chooses whether to remain in the industry or to exit to sell its resources to an entrant; and (ii) an active firm chooses how much capital and labor to employ, and hence output to produce. To characterize the intertemporal evolution of the distribution of firms, we discuss in particular how exit decisions, aggregate output, profits and distributions of firm productivities vary, (a) across different demand realization paths; (b) along a demand history path, detailing the effects of continued good or bad market conditions; and (c) for different anticipated future market conditions. Sufficient conditions are provide for worse demand realizations to lead to increased exit of low-productivity firms and then to improved distributions of firms at all future dates and states. Finally, it is shown that a downturn in demand can raise welfare due to the impact on exit decisions.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1043.pdf
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1043.

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Length: 33 pages
Date of creation: Jan 2006
Date of revision:
Handle: RePEc:qed:wpaper:1043

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Keywords: stochastic heterogeneity; aggregate shocks; exit; thin markets; demand uncertainty;

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References

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  1. Boyan Jovanovic & Glenn MacDonald, 1993. "The Life-Cycle of a Competitive Industry," NBER Working Papers 4441, National Bureau of Economic Research, Inc.
  2. 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.
  3. Bergin, J & Bernhardt, D, 1995. "Anonymous Sequential Games: Existence and Characterization of Equilibria," Economic Theory, Springer, vol. 5(3), pages 461-89, May.
  4. Dunne, T. & Roberts, M.J. & Samuelson, L., 1988. "Pattenrs Of Firm Entry And Exit In U.S. Manufacturing Industries," Papers 1-88-2, Pennsylvania State - Department of Economics.
  5. repec:att:wimass:8904 is not listed on IDEAS
  6. Baldwin,John R. & Gorecki,Paul With contributions by-Name:Caves,Richard E., 1995. "The Dynamics of Industrial Competition," Cambridge Books, Cambridge University Press, number 9780521465618.
  7. Jovanovic, Boyan & MacDonald, Glenn M, 1994. "Competitive Diffusion," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 24-52, February.
  8. Marcus Asplund & Volker Nocke, 2003. "Firm Turnover in Imperfectly Competitive Markets," PIER Working Paper Archive 03-010, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  9. Dunne, Timothy & Roberts, Mark J & Samuelson, Larry, 1989. "The Growth and Failure of U.S. Manufacturing Plants," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 671-98, November.
  10. Caballero, Ricardo J & Hammour, Mohamad L, 1994. "The Cleansing Effect of Recessions," American Economic Review, American Economic Association, vol. 84(5), pages 1350-68, December.
  11. Levinsohn, J. & Petrin, A., 1999. "When Industries Become More Productive, Do Firms?: Investigating Productivity Dynamics," Working Papers 445, Research Seminar in International Economics, University of Michigan.
  12. Jeffrey Campbell, 1998. "Entry, Exit, Embodied Technology, and Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(2), pages 371-408, April.
  13. Steve J. Davis & John Haltiwanger, 1991. "Gross Job Creation, Gross Job Destruction and Employment Reallocation," NBER Working Papers 3728, National Bureau of Economic Research, Inc.
  14. Dunne, T. & Roberts, M.J. & Samuelson L., 1988. "Plant Turnover And Gross Employment Flows In The U.S. Manufacturing Sector," Papers 9-87-7, Pennsylvania State - Department of Economics.
  15. Thomas F. Cooley & Vincenzo Quadrini, 1999. "Financial Markets and Firm Dynamics," Working Papers 99-14, New York University, Leonard N. Stern School of Business, Department of Economics.
  16. Ariel Pakes & Richard Ericson, 1989. "Empirical Implications of Alternative Models of Firm Dynamics," NBER Working Papers 2893, National Bureau of Economic Research, Inc.
  17. Bergin, James & Bernhardt, Dan, 1992. "Anonymous sequential games with aggregate uncertainty," Journal of Mathematical Economics, Elsevier, vol. 21(6), pages 543-562.
  18. 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.
  19. repec:fth:michin:445 is not listed on IDEAS
  20. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  21. Caballero, Ricardo J & Hammour, Mohamad L, 1996. "On the Timing and Efficiency of Creative Destruction," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 805-52, August.
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  23. Mallika Ishwaran, 2000. "Industry Dynamics: Aggregate Uncertainty, Heterogeneity, and the Entry and Exit of Firms," Econometric Society World Congress 2000 Contributed Papers 1135, Econometric Society.
  24. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, December.
  25. Baldwin, John R. & Gorecki, Paul K., 1987. "Plant creation versus plant acquisition : The entry process in canadian manufacturing," International Journal of Industrial Organization, Elsevier, vol. 5(1), pages 27-41, March.
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Citations

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Cited by:
  1. Santanu Roy & Takashi Kamihigashi, 2004. "Investment, Externalities & Industry Dynamics," Econometric Society 2004 North American Summer Meetings 144, Econometric Society.
  2. John Duggan, 2011. "Noisy Stochastic Games," RCER Working Papers 562, University of Rochester - Center for Economic Research (RCER).
  3. John Duggan, 2012. "Noisy Stochastic Games," RCER Working Papers 570, University of Rochester - Center for Economic Research (RCER).

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