Endogenous Entry, Product Variety, and Business Cycles

48 Pages Posted: 16 Sep 2011

See all articles by Florin Ovidiu Bilbiie

Florin Ovidiu Bilbiie

University of Oxford

Fabio Pietro Ghironi

University of Washington

Marc J. Melitz

Centre for Economic Policy Research (CEPR); Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 2011

Abstract

This paper builds a framework for the analysis of macroeconomic fluctuations that incorporates the endogenous determination of the number of producers and products 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 sunk entry costs and a time-to-build lag) generates a new and potentially important endogenous propagation mechanism for real business cycle models. The return to 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 procyclical product variety and procyclical profits even for preference specifications that imply countercyclical markups. When we include physical capital, the model can simultaneously reproduce most of the variance of GDP, hours worked, and total investment found in the data.

Keywords: business cycle propagation, entry, markups, product creation, profits, variety

JEL Classification: E20, E32

Suggested Citation

Bilbiie, Florin Ovidiu and Ghironi, Fabio Pietro and Melitz, Marc J. and Melitz, Marc J., Endogenous Entry, Product Variety, and Business Cycles (September 2011). CEPR Discussion Paper No. DP8564, Available at SSRN: https://ssrn.com/abstract=1928447

Florin Ovidiu Bilbiie (Contact Author)

University of Oxford ( email )

Oxford
United Kingdom

Fabio Pietro Ghironi

University of Washington ( email )

Department of Economics
Box 353330
Seattle, WA 98195-3330
United States
206-543-5795 (Phone)

HOME PAGE: http://faculty.washington.edu/ghiro

Marc J. Melitz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-8297 (Phone)
617-417-6536 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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