Nonlinear Production Networks with an Application to the Covid-19 Crisis

57 Pages Posted: 20 May 2020 Last revised: 28 May 2020

See all articles by D. R. Baqaee

D. R. Baqaee

University of California, Los Angeles (UCLA)

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2020

Abstract

We study the effects of negative supply shocks and shocks to the composition of final demand on aggregate output in a disaggregated neoclassical model with multiple sectors, factors, and input-output linkages. We show how nonlinearities associated with complementarities in consumption and production amplify the effect of negative supply shocks by creating supply bottlenecks and disrupting supply chain networks. These nonlinearities are particularly potent when the shocks are more heterogeneous as the worst-affected sectors drag down the other sectors. Nonlinearities are strengthened when changes in preferences lead households to tilt the composition of their demand towards the crippled sectors directly and indirectly through their supply chains. And nonlinearities are further intensified when factors cannot easily be reallocated across sectors to reinforce weak links. A quantitative investigation suggests that nonlinearities may amplify the impact of the Covid-19 shock by between 10%-100%, depending on the horizon of analysis and the exact size of the shocks.

Keywords: complementarities, COVID-19, input-output linkages, production networks

JEL Classification: E1, E3

Suggested Citation

Baqaee, D. R. and Farhi, Emmanuel, Nonlinear Production Networks with an Application to the Covid-19 Crisis (May 2020). CEPR Discussion Paper No. DP14742, Available at SSRN: https://ssrn.com/abstract=3603974

D. R. Baqaee (Contact Author)

University of California, Los Angeles (UCLA) ( email )

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Emmanuel Farhi

Harvard University - Department of Economics ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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