The neoclassical model and the welfare costs of selection

This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to evaluate the welfare cost of selection in the transition to steady state. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, initial capital destruction due to selection generates transitional welfare losses that may reduce in around 85% long term welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.