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An Alternative Theory of Firm and Industry Dynamics

Richard Ericson and Ariel Pakes ()
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Richard Ericson: Columbia University

No 1041, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: This paper provides a model of firm and industry dynamics that allows for entry, exit and firm-specific uncertainty generating variability in the fortunes of firms. It focuses on the impact of uncertainty arising from investment in research and exploration-type processes. It analyzes the behavior of individual firms exploring profit opportunities in an evolving marketplace and derives optimal policies, including exit, in this environment. Then it adds an entry process and aggregates the optimal behavior of all firms, including potential entrants, into a rational expectations, Markov perfect industry equilibrium, and proves ergodicity of the equilibrium process. Numerical examples are used to illustrate the more detailed characteristics of the stochastic process generating industry structures that result from this equilibrium.

Keywords: Industry dynamics; exploratory investment; heterogeneous firms; Markov perfect equilibrium (search for similar items in EconPapers)
JEL-codes: L11 C73 D40 D92 (search for similar items in EconPapers)
Date: 1992-12
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Published in Journal of Economic Theory (1998), 79(1): 1-46

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