IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Industry Dynamics: Aggregate Uncertainty, Heterogeneity, and the Entry and Exit of Firms

Listed author(s):
  • Mallika Ishwaran

    (Carnegie Mellon University)

Registered author(s):

    The aim of this paper is to investigate the relationship between heterogeneity at the firm level and the aggregate behavior of the industry as a whole. Empirical evidence on firm behavior documents the existence of widespread heterogeneity among firms in any industry, both cross- sectionally and over time. At the cross-sectional level, data indicates that industries are made up of firms of different sizes, ages, and productivity. These differences between firms imply that firm response to aggregate changes in the industry are varied and not exactly alike, as predicted by the representative firm models. It has also been noted that there exist differences in the evolution of firms with similar initial conditions, i.e., firms entering an industry at any given point in time follow very different capital growth paths. Whether these differences, be it at the cross-sectional level or over time, have a significant impact on the aggregate dynamics of the industry is the main focus of this paper. In the past few years, there has been an increase in interest in heterogeneous-agent models. The motivation for this has been the empirical observation of heterogeneity in the response of agents to aggregate changes. Thus, incorporating heterogeneity into models with aggregate uncertainty appears to be the logical next step. Incorporating heterogeneity allows us to evaluate whether heterogeneity at the microeconomic level plays a significant role in aggregate dynamics. Computing the equilibrium for such models has been a problem due to the lack of an analytical or close form solution. The trend has been towards using sophisticated computational techniques to arrive at the equilibrium. The use of computational methods has allowed us to solve and quantitatively analyze a whole range of models which would not have been possible otherwise. The purpose of the paper is to develop a dynamic model of firm and industry behavior that can be used to understand the relationship between firm-level decisions, aggregate uncertainty and the business cycle. The model developed assumes heterogeneous firms, and studies the investment behavior of these firms in response to aggregate shocks. It also looks at whether these differences at the microeconomic level have an impact on aggregate industry dynamics. Dropping the assumption of a representative firm also allows for the incorporation of firm entry and exit into this model. This enables us to study the changes in industry size and composition over time. This paper makes two contributions. First, it develops a model of investment behavior that reflects features observed in microeconomic data on firm behavior. It then studies the impact of these features on aggregate investment dynamics and the evolution of industries. In relaxing assumptions such as that of a representative firm, this paper provides a richer and more realistic framework within which to study investment dynamics. The second contribution of the paper is methodological. In the absence of an analytical solution, it develops a computational technique that allows for such a model to be solved for an approximate (numerical) equilibrium.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL:
    File Function: main text
    Download Restriction: no

    Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1135.

    in new window

    Date of creation: 01 Aug 2000
    Handle: RePEc:ecm:wc2000:1135
    Contact details of provider: Phone: 1 212 998 3820
    Fax: 1 212 995 4487
    Web page:

    More information through EDIRC

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:ecm:wc2000:1135. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.