Cascades and Fluctuations in an Economy with an Endogenous Production Network

46 Pages Posted: 3 Feb 2017 Last revised: 3 Jul 2017

Multiple version iconThere are 2 versions of this paper

Date Written: June 18, 2017

Abstract

This paper proposes a simple theory of production in which the network of input-output linkages is endogenously determined by the firms’ decisions to operate. Since producers benefit from having multiple suppliers, the economy features complementarities between the operating decisions of nearby firms. As a result, tightly connected clusters of producers emerge around productive firms. In addition, after a firm is hit by a severe shock, a cascade of shutdowns might spread from neighbor to neighbor as the network reorganizes itself. While well-connected firms are better able to withstand shocks, they trigger larger cascades upon shut down. The theory also predicts how the shape of the network interacts with the business cycle. As in the U.S. data, periods of low economic activity feature fewer well-connected producers and less clustering among firms. Once calibrated, the model predicts that allowing the network to reorganize itself in response to shocks leads to substantially smaller variations in aggregate output, suggesting that endogenous changes in the shape of the production network have a significant impact on the aggregation of microeconomic shocks into macroeconomic fluctuations.

Suggested Citation

Taschereau-Dumouchel, Mathieu, Cascades and Fluctuations in an Economy with an Endogenous Production Network (June 18, 2017). Available at SSRN: https://ssrn.com/abstract=2910068 or http://dx.doi.org/10.2139/ssrn.2910068

Mathieu Taschereau-Dumouchel (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

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