Endogenous Entry, Product Variety, and Business Cycles

Florin O. Bilbiie, Fabio Ghironi () and Marc J. Melitz

No 13646, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper builds a framework for the analysis of macroeconomic fluctuations that incorporates the endogenous determination of the number of producers 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 the sunk entry costs) generates a new and potentially important endogenous propagation mechanism for real business cycle models. The stock-market price of 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 a procyclical number of producers and procyclical profits even for preference specifications that imply countercyclical markups. When we include physical capital, the model can reproduce the variance and autocorrelation of GDP found in the data.

JEL-codes: E20 E32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-dge and nep-mac
Date: Written 2007-11
Note: EFG
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