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Cascading Failures in Production Networks

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  • David Baqaee

    (London School of Economics and Political Science)

Abstract

I show how the extensive margin of firm entry and exit can greatly amplify idiosyncratic shocks in an economy with a production network. I show that input-output models with entry and exit behave very differently to models without this margin. In particular, in such models, sales provide a very poor measure of the systemic importance of firms or industries. I derive a new notion of systemic influence called exit centrality that captures how exits in one industry will affect equilibrium output. I show that exit centrality need not be related to an industry’s sales, size, or prices. Unlike the relevant notions of centrality in standard input-output models, exit centrality depends on the industry’s role as both a supplier and as a consumer of inputs, as well as market structure. I show that, unlike competitive models, vanishingly small industries can have arbitrarily large effects on equilibrium outcomes. In this sense, the network can amplify shocks in a way that standard input-output models cannot.

Suggested Citation

  • David Baqaee, 2016. "Cascading Failures in Production Networks," 2016 Meeting Papers 402, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:402
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