Endogenous Production Networks under Supply Chain Uncertainty
92 Pages Posted: 11 Oct 2021 Last revised: 21 Nov 2022
Date Written: October 5, 2021
Supply chain disturbances can lead to substantial increases in production costs. To mitigate these risks, firms may take steps to reduce their reliance on volatile suppliers. We construct a model of endogenous network formation to investigate how these decisions affect the structure of the production network and the level and volatility of macroeconomic aggregates. When uncertainty increases in the model, producers prefer to purchase from more stable suppliers, even though they might sell at higher prices. The resulting reorganization of the network leads to less macroeconomic volatility, but at the cost of a decline in aggregate output. The model also predicts that more productive and stable firms have higher Domar weights—a measure of their importance as suppliers—in the equilibrium network. We calibrate the model to U.S. data and find that the mechanism can account for a sizable decline in expected GDP during periods of high uncertainty like the Great Recession.
Keywords: uncertainty, production network, endogenous network, input output table, supply chain, risk
JEL Classification: E32, C67, D57, D80, D85
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