Supply Network Formation and Fragility

Abstract

We model the production of complex goods in a large supply network. Each firm
sources several essential inputs through relationships with other firms. Due to the risk of such
supply relationships being idiosyncratically disrupted, firms multisource inputs and strategically
invest to make relationships with suppliers stronger. Aggregate production is robust to idiosyncratic
disruptions. However, there is a regime in which equilibrium supply networks are fragile, with
small aggregate shocks to relationships causing arbitrarily steep drops in output. The endogenous
configuration of supply networks provides a new channel for the powerful amplification of shocks.

Keywords: network formation, fragility, reliability, robustness

JEL Classification: D85