NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Firm Heterogeneity, Endogenous Entry, and the Business Cycle

Gianmarco I.P. Ottaviano

NBER Working Paper No. 17433
Issued in September 2011
NBER Program(s):   EFG

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.

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Document Object Identifier (DOI): 10.3386/w17433

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