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Endogenous Entry, Product Variety and Business Cycles

  • Florin Bilbiie


    (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics)

  • Fabio Ghironi

    (Department of Economics - Boston College)

  • Marc Melitz

    (Department of Economics - Harvard University [Cambridge])

This paper builds a framework for the analysis of macroeconomic fluctuations that incorporates the endogenous determination of the number of producers and products over the business cycle. Economic expansions induce higher entry rates by prospective entrants subject to irreversible investment costs. The sluggish response of the number of producers (due to sunk entry costs and a time-to-build lag) generates a new and potentially important endogenous propagation mechanism for real business cycle models. The return to investment (corresponding to the creation of new productive units) determines household saving decisions, producer entry, and the allocation of labor across sectors. The model performs at least as well as the benchmark real business cycle model with respect to the implied second-moment properties of key macroeconomic aggregates. In addition, our framework jointly predicts procyclical product variety and procyclical profits even for preference specifications that imply countercyclical markups. When we include physical capital, the model can simultaneously reproduce most of the variance of GDP, hours worked, and total investment found in the data.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number hal-00680634.

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Date of creation: 2012
Date of revision:
Publication status: Published in Journal of Political Economy, University of Chicago Press, 2012, 120 (2), pp.304-345. <10.1086/665825>
Handle: RePEc:hal:cesptp:hal-00680634
DOI: 10.1086/665825
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