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Investment, Externalities & Industry Dynamics

  • Santanu Roy
  • Takashi Kamihigashi

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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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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  1. Jovanovic, Boyan & MacDonald, Glenn M, 1994. "The Life Cycle of a Competitive Industry," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 322-47, April.
  2. 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.
  3. Jovanovic, Boyan & Lach, Saul, 1988. "Entry, Exit, And Diffusion With Learning By Doing," Working Papers 88-16, C.V. Starr Center for Applied Economics, New York University.
  4. James Bergin & Dan Bernhardt, 2006. "Industry Dynamics with Stochastic Demand," Working Papers 1043, Queen's University, Department of Economics.
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  14. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  15. 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.
  16. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
  17. 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.
  18. Hugo A. Hopenhayn, 1993. "The shakeout," Economics Working Papers 33, Department of Economics and Business, Universitat Pompeu Fabra.
  19. 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.
  20. 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.
  21. Lambson, V.E., 1989. "Industry Evolution With Sunk Costs And Uncertian Market Conditions," Working papers 8904, Wisconsin Madison - Social Systems.
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