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Consumer search and firm growth

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  • Erzo G. J. Luttmer

Abstract

This paper presents a simple model of search and matching between consumers and firms. The firm size distribution has a Pareto-like right tail if the population of consumers grows at a positive rate and the mean rate at which incumbent firms gain customers is also positive. This happens in equilibrium when entry is sufficiently costly. As entry costs grow without bound, the size distribution approaches Zipf's law. The slow rate at which the right tail of the size distribution decays and the 10% annual gross entry rate of new firms observed in the data suggest that more than a third of all consumers must switch from one firm to another during a given year. A substantially lower consumer switching rate can be inferred only if part of the observed firm entry rate is attributed to factors outside the model. The realized growth rates of large firms in the model are too smooth.

Suggested Citation

  • Erzo G. J. Luttmer, 2006. "Consumer search and firm growth," Working Papers 645, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmwp:645
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    References listed on IDEAS

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    1. Xavier Gabaix & Augustin Landier, 2008. "Why has CEO Pay Increased So Much?," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 49-100.
    2. Rasmus Lentz & Dale T. Mortensen, 2008. "An Empirical Model of Growth Through Product Innovation," Econometrica, Econometric Society, vol. 76(6), pages 1317-1373, November.
    3. Glenn Ellison & Drew Fudenberg, 1995. "Word-of-Mouth Communication and Social Learning," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 93-125.
    4. Stephen Hymer & Peter Pashigian, 1962. "Firm Size and Rate of Growth," Journal of Political Economy, University of Chicago Press, vol. 70, pages 556-556.
    5. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
    6. Xavier Gabaix, 2011. "The Granular Origins of Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(3), pages 733-772, May.
    7. 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.
    8. Rafael Rob & Arthur Fishman, 2005. "Is Bigger Better? Customer Base Expansion through Word-of-Mouth Reputation," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 1146-1175, October.
    9. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-670, May.
    10. Burdett, Kenneth & Vishwanath, Tara, 1988. "Balanced Matching and Labor Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 1048-1065, October.
    11. Matthew O. Jackson & Brian W. Rogers, 2007. "Meeting Strangers and Friends of Friends: How Random Are Social Networks?," American Economic Review, American Economic Association, vol. 97(3), pages 890-915, June.
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    Cited by:

    1. University of Minnesota & Erzo G.J. Luttmer, 2007. "New Goods and the Size Distribution of Firms," 2007 Meeting Papers 266, Society for Economic Dynamics.
    2. Erzo G.J. Luttmer, 2010. "Models of Growth and Firm Heterogeneity," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 547-576, September.
    3. Erzo G. J. Luttmer, 2011. "On the Mechanics of Firm Growth," Review of Economic Studies, Oxford University Press, vol. 78(3), pages 1042-1068.

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    Keywords

    Econometric models;

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