ECON 357

Lecture 7: the distribution of …rm sizes

Thomas Chaney

University of Chicago

Thomas Chaney (Chicago) ECON 357: Lecture 7 1 / 23

Motivation

Productivity distribution governs …rm level and aggregate trade

patterns in:
Melitz/Chaney
Eaton-Kortum/BEJK
Melitz-Ottaviano
Distortions of the productivity distribution can have large e¤ects on
e¢ ciency:
Trade in Melitz
Hsieh-Klenow
Well calibrated random mechanical model describes trade patterns
well:
Armenter-Koren (Balls and Bins)

Thomas Chaney (Chicago) ECON 357: Lecture 7 2 / 23

Motivation
Very stable …rm size distribution (source: Axtell, Science 2001):

Figure: R2 = .992, slope 1.059.

Thomas Chaney (Chicago) ECON 357: Lecture 7 3 / 23
Motivation
Pareto distributions and Zipf’s law appear often in social science and
nature (e.g. city sizes, Gabaix, QJE 1999)

Figure: ln(Rank) = 10.53 1.005 ln (Size)

(.010 )
Thomas Chaney (Chicago) ECON 357: Lecture 7 4 / 23
Motivation
Pareto distributions and Zipf’s law holds even for "small" cities
(Rozenfeld, Rybski, Gabaix and Maske, AER 2010)

Figure: Zipf holds for cities above 5,000 inhabitants.

Thomas Chaney (Chicago) ECON 357: Lecture 7 5 / 23
Motivation
Small departures from Pareto/Zipf:

Figure: Luttmer (QJE 2007).

Thomas Chaney (Chicago) ECON 357: Lecture 7 6 / 23

Target

Generate stable Zipf distribution from a simple stochastic process.

Yule (1925): distribution of # of species within biological genera.
Simon (1955), Simon & Bonini (AER 1958): distribution of …rm sizes.
Gabaix (QJE 1999): distribution of city sizes.
Luttmer (QJE 2007): distribution of …rm sizes.
Chatterejee & Rossi-Hansberg (2009): distribution of …rm sizes across
sectors.

Thomas Chaney (Chicago) ECON 357: Lecture 7 7 / 23

Gibrat’s law

Random growth of …rm size,

Sti +1 = γit Sti

with γit i.i.d. draws from p.d.f. fS (γ)

Gibrat’s law: for "large" …rms, growth rate of size is roughly
independent of …rm size,

fS (γ) = fS 0 (γ) = f (γ) for S, S 0 "large"

Thomas Chaney (Chicago) ECON 357: Lecture 7 8 / 23

Gabaix (QJE 1999)

Continuous time stochastic growth process for population size (Pit ),

dPit /Pit = γdt + σdBit

with γ (σ) average (s.d. of) growth of city size, and B a Brownian
motion.
Normalization,
dSit /Sit = µdt + σdBit
with Sit = Pit / (total population), and µ = γ (S ) γ̄.

Thomas Chaney (Chicago) ECON 357: Lecture 7 9 / 23

Degenerate log-normal limit

This process converges to a log-normal,

St = S0 exp σ2 t/2 + σBt

No steady state: log-normal keeps "fanning out".

Thomas Chaney (Chicago) ECON 357: Lecture 7 10 / 23

Small perturbation generates Zipf

Assume there is a minimal city size, Smin (can be arbitrarily small).

Re‡ected geometric Brownian motion close to the barrier,

dSt /St = max (µdt + σdBit , 0) at St = Smin

Proposition
If S follows a re‡ected geometric Brownian motion, then the distribution
of S converges to a Pareto distribution,
ζ
Pr S̃ > S = (S /Smin )

with ζ = 1/ (1 Smin /S̄ ).

Thomas Chaney (Chicago) ECON 357: Lecture 7 11 / 23

Yule distribution (Yule 1925, Simon & Bonini 1958)

Proposition
Assume Gibrat’s law for existing …rms, and entry of new …rms at Smin .
Then the size distribution converges to,

f (S ) = KB (S, ζ + 1)

with B ( , ) the Beta distribution, which asymptotes to a Pareto

distribution (p.d.f.),
f (S ) ! MS (ζ +1 )
S !+∞

for a constant ζ given by,

1
ζ=
1 g /G
with g the growth from new …rms, and G the growth from existing …rms.

Thomas Chaney (Chicago) ECON 357: Lecture 7 12 / 23

Limitations of Simon’s results

1 To match Zipf’s law, ζ 1, one needs g /G 0.

With g /G 0, the process converges extremely slowly.
2 One needs that growth of # of cities (…rms) > growth of population.
Counterfactual.

Thomas Chaney (Chicago) ECON 357: Lecture 7 13 / 23

Using …rm size distribution to learn about economic forces

Luttmer (QJE 2007) can match:

ratio of (…xed) entry cost to (…xed) operating cost.
ratio of (…xed) entry cost to (…xed) imitation cost.
Chaterjee & Rossi-Hansberg (2009) can match:
relative contribution to growth of new …rms versus existing …rms.
size of "teams" within …rms.

Thomas Chaney (Chicago) ECON 357: Lecture 7 14 / 23

Chatterjee & Rossi-Hansberg (2009): all …rms

Match relative contribution to growth of new …rms versus existing …rms

Thomas Chaney (Chicago) ECON 357: Lecture 7 15 / 23
Chatterjee & Rossi-Hansberg (2009): sectors

Thomas Chaney (Chicago) ECON 357: Lecture 7 16 / 23

Chatterjee & Rossi-Hansberg (2009): sectors (cont’d)

Thomas Chaney (Chicago) ECON 357: Lecture 7 17 / 23

Chatterjee & Rossi-Hansberg (2009)

Model makes prediction about both …rm size distribution and some
fundamental parameters.
Match …rm size distribution and predict:
1 Relative contribution to growth of new versus existing …rms
Aggregate data gets the rigth g /G .
2 Size of "teams" within …rms:
Sectoral data gets the right size of "teams".

Thomas Chaney (Chicago) ECON 357: Lecture 7 18 / 23

Size distribution, innovation and growth

If innovation is a contest (the best wins), then Extreme Value

Distribution Theory (EVT) can be used.
Kortum (ECMA 1994), Eaton & Kortum (IER 1999), Lucas (2009).
Stable asymptotic size distribution of …rm sizes (EK), incomes
(Lucas).

Thomas Chaney (Chicago) ECON 357: Lecture 7 19 / 23

Social networks (Matt Jackson, Stanford)

If …rms meet the "friends of their friends", then stable network

emerges.
Jackson & Rogers (AER 2007) test some predictions of network
theory in di¤erent social settings.

Thomas Chaney (Chicago) ECON 357: Lecture 7 20 / 23

Social networks and trade (Chaney 2010)

Jackson & Rogers (AER 2007) embedded into geographic space:

1 Distribution of the number of exports destinations is assymptotically
Pareto.
2 Distance from exporters increases with number of foreign contacts.
3 The more contacts a …rm has, the more likely it is to enter new
countries.
4 If Japan is close to Korea, an exporter to Japan is more likely to enter
Korea.
5 If Spain trades a lot with Chile, an exporter to Spain is more likely to
enter Chile.

Thomas Chaney (Chicago) ECON 357: Lecture 7 21 / 23

How many …rms export to M markets?

Thomas Chaney (Chicago) ECON 357: Lecture 7 22 / 23

How far does a …rm export to?

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