Dynamic inefficiency with a decreasing returns technology for firms

In this paper, we highlight the possibility of dynamically inefficient equilibria in a model with strictly convex production function at the firm’s level. Decreasing returns imply the existence of some pure profit and hence of an asset market. We endogenise the number of firms by introducing a sunk cost that is to be paid upon entering into the market; since this cost is assumed to be constant, the number of firms increases over time in response out that the growth of the number of firms reduces the rate used to discount future profits, allowing for dynamic inefficiency. We also consider the presence of a constant and exogenous probability of failure affecting firms.