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An Alternative Theory of Firm and Industry Dynamics

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Abstract

This paper provides a model of firm and industry dynamics that allows for entry, exit and firm-specific uncertainty generating variability in the fortunes of firms. It focuses on the impact of uncertainty arising from investment in research and exploration-type processes. It analyzes the behavior of individual firms exploring profit opportunities in an evolving marketplace and derives optimal policies, including exit, in this environment. Then it adds an entry process and aggregates the optimal behavior of all firms, including potential entrants, into a rational expectations, Markov perfect industry equilibrium, and proves ergodicity of the equilibrium process. Numerical examples are used to illustrate the more detailed characteristics of the stochastic process generating industry structures that result from this equilibrium.

Suggested Citation

  • Richard Ericson & Ariel Pakes, 1992. "An Alternative Theory of Firm and Industry Dynamics," Cowles Foundation Discussion Papers 1041, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:1041
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    File URL: http://cowles.yale.edu/sites/default/files/files/pub/d10/d1041.pdf
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    1. Cefis, Elena & Orsenigo, Luigi, 2001. "The persistence of innovative activities: A cross-countries and cross-sectors comparative analysis," Research Policy, Elsevier, vol. 30(7), pages 1139-1158, August.
    2. Richard I.D. Harris & Qian Cher Li, "undated". "Export-market dynamics and the probability of firm closure: Evidence for the UK," Working Papers 2008_17, Business School - Economics, University of Glasgow.
    3. Gary Gorton & Matthias Kahl & Richard Rosen, 2005. "Eat or Be Eaten: A Theory of Mergers and Merger Waves," NBER Working Papers 11364, National Bureau of Economic Research, Inc.
    4. Baldwin, John R. & Rafiquzzaman, Mohammed, 1995. "Selection versus evolutionary adaptation: Learning and post-entry performance," International Journal of Industrial Organization, Elsevier, vol. 13(4), pages 501-522, December.
    5. Bhattacharjee, A. & Higson, C. & Holly, S. & Kattuman, P., 2004. "Business Failure in UK and US Quoted Firms: Impact of Macroeconomic Instability and the Role of Legal Institutions," Cambridge Working Papers in Economics 0420, Faculty of Economics, University of Cambridge.
    6. Dolores Añón Higón & Miguel Manjón & Juan A. Máñez & Juan A. Sanchis-Llopis, 2014. "Does R&D Protect Smes From The Hardness Of The Cycle? Evidence From Spanish Smes (1990-2009)," Working Papers 1411, Department of Applied Economics II, Universidad de Valencia.
    7. Steven J. Davis & John Haltiwanger, 1996. "Employer Size and the Wage Structure in U.S. Manufacturing," Annals of Economics and Statistics, GENES, issue 41-42, pages 323-367.
    8. Flora Bellone & Patrick Musso & Michel Quéré & Lionel Nesta, 2006. "Productivity and Market Selection of French Manufacturing Firms in the Nineties," Revue de l'OFCE, Presses de Sciences-Po, vol. 97(5), pages 319-349.
    9. Loof, Hans & Heshmati, Almas, 2002. "Knowledge capital and performance heterogeneity: : A firm-level innovation study," International Journal of Production Economics, Elsevier, vol. 76(1), pages 61-85, March.
    10. Lucia Foster & John C. Haltiwanger & C. J. Krizan, 2001. "Aggregate Productivity Growth: Lessons from Microeconomic Evidence," NBER Chapters,in: New Developments in Productivity Analysis, pages 303-372 National Bureau of Economic Research, Inc.
    11. Saul Lach & Rafael Rob, 1996. "R&D, Investment, and Industry Dynamics," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 5(2), pages 217-249, June.
    12. Maskin, Eric & Tirole, Jean, 2001. "Markov Perfect Equilibrium: I. Observable Actions," Journal of Economic Theory, Elsevier, vol. 100(2), pages 191-219, October.
    13. Olley, G Steven & Pakes, Ariel, 1996. "The Dynamics of Productivity in the Telecommunications Equipment Industry," Econometrica, Econometric Society, vol. 64(6), pages 1263-1297, November.
    14. Malerba, Franco & Orsenigo, Luigi & Peretto, Pietro, 1997. "Persistence of innovative activities, sectoral patterns of innovation and international technological specialization," International Journal of Industrial Organization, Elsevier, vol. 15(6), pages 801-826, October.
    15. María Rochina-Barrachina & Juan Mañez & Juan Sanchis-Llopis, 2010. "Process innovations and firm productivity growth," Small Business Economics, Springer, vol. 34(2), pages 147-166, February.
    16. Andersson, Fredrik, 1999. "Job flows in Swedish manufacturing 1972-1996," Working Paper Series 1999:4, IFAU - Institute for Evaluation of Labour Market and Education Policy.
    17. Clarida, Richard H, 1993. "Entry, Dumping, and Shakeout," American Economic Review, American Economic Association, vol. 83(1), pages 180-202, March.
    18. Gong, Binlei & Sickles, Robin C., 2016. "Non-structural and Structural Models in Productivity Analysis: Study of the British Isles during the 2007-2009 Financial Crisis," Working Papers 16-004, Rice University, Department of Economics.
    19. Mark Schankerman, 1991. "Revisions and Investment Plans and the Stock Market Rate of Return," NBER Working Papers 3937, National Bureau of Economic Research, Inc.
    20. Stefan Kersting & JProf. Silke Huettel & Prof. Martin Odening, 2013. "Structural change in agriculture – an equilibrium approach," EcoMod2013 5300, EcoMod.
    21. Cefis, Elena, 2003. "Is there persistence in innovative activities?," International Journal of Industrial Organization, Elsevier, vol. 21(4), pages 489-515, April.

    More about this item

    Keywords

    Industry dynamics; exploratory investment; heterogeneous firms; Markov perfect equilibrium;

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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