Business Networks, Production Chains, and Productivity: A Theory of Input-Output Architecture

Abstract

This paper develops a theory of the formation and evolution of chains of production. Entrepreneurs search for production techniques that use alternative sets of inputs, which are in turn produced by other entrepreneurs. The value of a technique depends both on its inherent productivity and on the cost of associated inputs; when producing, each entrepreneur selects the technique that delivers the best combination. These choices collectively determine the economy's equilibrium input-output structure. As new techniques are discovered, entrepreneurs substitute across suppliers in response to changing input prices. Despite the network structure, the model is analytically tractable, allowing for sharp characterizations of aggregate productivity and various firm-level characteristics. Aggregate productivity depends on how frequently the lower-cost firms are selected as suppliers. When the share of intermediate goods in production is high, star suppliers emerge endogenously, increasing the concentration of sales of intermediate goods and raising aggregate output.

Keywords: Networks, Productivity, Supply Chains, Ideas, Diffusion

JEL Classification: O31, O33, O47