Industry Dynamics

We develop a theoretical model of the dynamics of an industry over the business cycle. We characterize the intertemporal evolution of the distribution of firms, where firms are distinguished by their capital in place and the productivity of their technology. We contrast investment and exit decisions and their consequences for aggregate output, profits and productivity distributions: (a.) across different demand realization paths; (b.) along a demand history path, detailing the effects of continued good or bad market conditions; and (c.) we consider the impact of different anticipated future market conditions. We also characterize exit rates by age, size and productivity. The theoretical model generates predictions that are broadly consistent with empirical findings: downturns in demand lead to higher exit of inefficient firms and hence increased future productivity; recessions are shorter and sharper than expansions; younger, smaller or less productive firms are more likely to exit; etc