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The size distribution of firms in an economy with fixed and entry costs

Listed author(s):
  • Erzo G. J. Luttmer

This paper describes an analytically tractable model of balanced growth that allows for extensive heterogeneity in the technologies used by firms. Firms enter with fixed characteristics that determine their initial technologies and the levels of fixed costs required to stay in business. Each firm produces a different good, and firms are subject to productivity and demand shocks that are independent across firms and over time. Firms exit when revenues are too low relative to fixed costs. Conditional on fixed firm characteristics, the stationary distribution of firm size satisfies a power law for all sizes above the size at which new firms enter. The tail of the size distribution decays very slowly if the growth rate of the initial productivity of potential entrants is not too far above the growth rate of productivity inside incumbent firms. In one interpretation, this difference in growth rates can be related to learning-by-doing inside firms and spillovers of the information generated as a result. As documented in a companion paper, heterogeneity in fixed firm characteristics together with idiosyncratic firm productivity growth can generate entry, exit, and growth rates, conditional on age and size, in line with what is observed in the data.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 633.

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Date of creation: 2004
Handle: RePEc:fip:fedmwp:633
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  1. Eaton, Jonathan & Eckstein, Zvi, 1997. "Cities and growth: Theory and evidence from France and Japan," Regional Science and Urban Economics, Elsevier, vol. 27(4-5), pages 443-474, August.
  2. repec:ucp:bknber:9780226304557 is not listed on IDEAS
  3. Esteban Rossi-Hansberg & Mark L. J. Wright, 2007. "Urban Structure and Growth," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 597-624.
  4. Mark L.J. Wright & Esteban Rossi-Hansberg, 2004. "Firm Size Dynamics in the Aggregate Economy," 2004 Meeting Papers 878, Society for Economic Dynamics.
  5. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
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  10. Erzo G.J. Luttmer, 2004. "On the Age and Size Distribution of Business Firms," 2004 Meeting Papers 686, Society for Economic Dynamics.
  11. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 1997. "Long-Run Implications of Investment-Specific Technological Change," American Economic Review, American Economic Association, vol. 87(3), pages 342-362, June.
  12. Peter J. Klenow, 2003. "Measuring consumption growth: the impact of new and better products," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 10-23.
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  18. Tor Jakob Klette & Samuel Kortum, 2004. "Innovating Firms and Aggregate Innovation," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 986-1018, October.
  19. Robert J. Gordon, 2000. "The Boskin Commission Report and its Aftermath," NBER Working Papers 7759, National Bureau of Economic Research, Inc.
  20. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-670, May.
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  22. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-1150, September.
  23. Xavier Gabaix, 1999. "Zipf's Law for Cities: An Explanation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 739-767.
  24. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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