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Firm Heterogeneity, Endogenous Entry, and the Business Cycle


  • Gianmarco I.P. Ottaviano


This paper investigates the role that the entry and exit of heterogeneous firms plays in shaping aggregate fluctuations in economic activity. In so doing, it develops a dynamic stochastic general equilibrium model in which procyclical entry and countercyclical exit along a real business cycle lead to endogenous cyclical movements in average firm productivity. These movements stem from a composition effect due to the reallocation of market shares among firms with different levels of efficiency and affect the propagation of exogenous technological shocks. Numerical analysis suggests that existing models with representative firms may overstate the actual role of procyclical entry and exit in imperfectly competitive markets as a propagation mechanism of exogenous technology shocks. The reason is that procyclical entry and countercyclical exit disproportionately involve less efficiency firms whose impact on aggregate economic activity is hampered by their smaller size.

Suggested Citation

  • Gianmarco I.P. Ottaviano, 2011. "Firm Heterogeneity, Endogenous Entry, and the Business Cycle," NBER Working Papers 17433, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17433
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    References listed on IDEAS

    1. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
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    4. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2012. "Endogenous Entry, Product Variety, and Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 304-345.
    5. Marc J. Melitz & Gianmarco I. P. Ottaviano, 2008. "Market Size, Trade, and Productivity," Review of Economic Studies, Oxford University Press, vol. 75(1), pages 295-316.
    6. J. Peter Neary, 2007. "Cross-Border Mergers as Instruments of Comparative Advantage," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1229-1257.
    7. Christian Broda & David E. Weinstein, 2010. "Product Creation and Destruction: Evidence and Price Implications," American Economic Review, American Economic Association, vol. 100(3), pages 691-723, June.
    8. Gali Jordi, 1994. "Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand," Journal of Economic Theory, Elsevier, vol. 63(1), pages 73-96, June.
    9. Katharine G. Abraham & John C. Haltiwanger, 1995. "Real Wages and the Business Cycle," Journal of Economic Literature, American Economic Association, vol. 33(3), pages 1215-1264, September.
    10. Jaimovich, Nir & Floetotto, Max, 2008. "Firm dynamics, markup variations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1238-1252, October.
    11. Steven J. Davis & John Haltiwanger, 1990. "Gross Job Creation and Destruction: Microeconomic Evidence and Macroeconomic Implications," NBER Chapters,in: NBER Macroeconomics Annual 1990, Volume 5, pages 123-186 National Bureau of Economic Research, Inc.
    12. Steven J. Davis & R. Jason Faberman & John Haltiwanger, 2006. "The Flow Approach to Labor Markets: New Data Sources and Micro-Macro Links," Journal of Economic Perspectives, American Economic Association, vol. 20(3), pages 3-26, Summer.
    13. 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.
    14. Choi, E. Kwan & Harrigan, James, 2003. "Handbook of International Trade," Staff General Research Papers Archive 11375, Iowa State University, Department of Economics.
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    Cited by:

    1. Churen Sun & Guoqiang Tian & Tao Zhang, 2013. "Special Issue. Guest Editor: Zhihao Yu," Review of Development Economics, Wiley Blackwell, vol. 17(3), pages 494-509, August.
    2. Sun, Churen & Zhang, Tao, 2012. "Export, Productivity Pattern, and Firm Size Distribution," MPRA Paper 36742, University Library of Munich, Germany.
    3. Etro, Federico, 2016. "The Ramsey model with monopolistic competition and general preferences," Economics Letters, Elsevier, vol. 145(C), pages 141-144.
    4. Ottaviano, Gianmarco I.P., 2012. "Agglomeration, trade and selection," Regional Science and Urban Economics, Elsevier, vol. 42(6), pages 987-997.
    5. Sun, Churen & Tian, Guoqiang & Zhang, Tao, 2011. "When Pareto meets Melitz: the inapplicability of the Melitz-Pareto model for Chinese firms," MPRA Paper 35597, University Library of Munich, Germany.
    6. Pavol Majher, 2015. "Firm entry and exit, investment irreversibility, and business cycle dynamics," Vienna Economics Papers 1513, University of Vienna, Department of Economics.

    More about this item

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure

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