Entry, Exit, and firm dynamics

in long run equilibrium.

summary
• Idea- to create a steady state analysis of industry equilibrium model.
• Resources are reallocated across the firms from ‘exiting/contracting’ one’s
to ‘expanding/new entrants’. These raises two important facts:
a. Firm specific uncertainty impacts the dynamics at the firm level.
b. Entry and exits are highly correlated across industries and are impacted
by industry effects(turnover rates).
Model:
1. Firm faces individual productivity shocks
2. Based on shocks decides to leave or stay back
3. There is an entry cost which is a non-recoverable investment eventually
becomes sunk.
4. Steady state explains about stationary distribution of profits, value etc.
• Aggregate demand is given by the inverse demand function D(Q), and the input price by W(N), N is
total industry demand for the input, i.e. labour here.
• Assumptions:
A.1 D is continuous, strictly decreasing; W is continuous , non-decreasing and strictly bounded above
zero.
[*output of an individual firm q=f(ϕ,n), where ϕ ϵ S ≡ [0,1] is a productivity shock which follows a
Markov process independent across firm with conditional distribution. There is fixed cost to be paid up
by the incumbent firms, , every period. Firms discount profits with a constant factor 0<β<1.]
A.2 this implies that expected discounted profits are an increasing function of a firm's current shock. In
equilibrium firms exit the industry whenever their state falls below a reservation level x.
A.3 says the higher is the productivity shock in period t, the more likely are higher shocks in period t + 1
A.4 implies that the life span of a firm is almost surely finite, preventing the mass of firms from escaping
to a no exit region. Each period, before the new shocks are realized, incumbent firms may exit the
industry and potential entrants may enter. A firm that exits secures a present value which we normalize
to zero. To enter, a firm must pay an entry cost >= 0. After paying this cost its productivity shock, which
is drawn from an initial distribution v, is revealed.
A.5 v has a continuous distribution function G.
Model:
• After the shock in time period t firm decides output and productivity
as per the impact of shock in time period t+1, the shock is said to be
S, A is a subset of S which impacts the mass of firms in time t as well
as t+1. so total no. of firms or mass of firms is = in case of impact of
shocks A the mass, = , which is state of industry in period t. hence
aggregate output supply and input demand functions of all firms;
•
• Source of uncertainty- firm specific productivity shock
• Initial state of firms are same, but since there is no industry-wise
shocks therefore each firm will react differently and shock ϕ follows
deterministic path.
• Equilibrium is attained :
• Proposition 1 explains – about the discounted profit being uniform in
continuous impact of shock,ϕ, this proposition explains new firms will
enter until the expected discounted profits net of entry cost is zero.
• Equation 5) explains expected discounted profit of potential entrant.
6) explains that shocks could either have 0 impact or will impact fully,
which will influence the rule for entry and exit.
• Equation 7) is the ARDL form where shock at t period impacts firms discounted
profit in t+1 time period, the last term explains that.

• Equilibrium is attained when net discounted surplus is maximized.

• Theorem 1 and 2 explains about the uniqueness and stability of this
competitive equilibrium.
• 8) solves the sequential problem, also the sets here are closed borel sets and
convex in nature. So 8) is the maximizing problem, net discounted is maximized
here. All the sets are bounded and continuous.
• Theorem 1- given an initial distribution as initial shock, there exists a unique
equilibrium. To establish the uniqueness, 0th period and 1st period input-
output vectors are considered, and also it is observed that and are the
convex combinations. Two distinct equilibrium for allocation exists at the
same prices. So the aggregate output will be same and as well as the rule for
exit will be same for firms in both period.
• Section 4 provides details about stationary equilibrium. Expected prices for
produced good and input depends on , the current profits will be based on
the type of firms, their expected prices of output and input post productivity
shock. Hence equation 9) will give unique solution.
• Proposition 2) explains about the continuity of v i.e discounted profit
function and proposition 3) explains the uniqueness and continuity of the
solution.
• Equation 10) & 11) explains about necessary conditions for an equilibrium
with , to exhibit positive entry of a firm.
• Now if m(x,M) is exit rule for x and mass entrant of firms M, acts as
transition operator for exit rule in equation 12).
• Now be entry rule with exit rule for x firms is optimal, while explains
if x is the exit rule, the mass entrants will expect that cost of entry and
expected discounted profit will be equal.
• A. both are equal with positive entry.
• B. if greater implies increased no. of entrants.
• C. if smaller implies exit of incumbent firms.
• Theorem 2 related to theorem 3- cost of entry acts an entry barrier,
but barrier relative to demand with positive entry can explain about
stationary competitive equilibrium. & be corresponding measures of
shock in period 1 & 2, so there can be some shock ϕ, for which < and
vice-versa thus this implies that productivity states can absorb the
impact of shock ϕ in the same direction.
• With condition U.1 and U.2 there can be established that competitive
equilibrium exists, with possibility of positive entry and exit.
• Theorem 4 suggest if either U.1 or U.2 is satisfied equilibrium exists,
unique and has positive entry and exit. Suppose cost function c(.) is
given which satisfies U.1, production functions of the form f(ϕ,n)=
ϕg(n), and g is homogenous of degree k(0,1), profit functions are of
c.e.s function which satisfies U.2
• X>0, exit rule & M>0

This explains that as per the cohort age of the firms, the stopping
time(avg age of firm during exit) or exit rule is derived. Existence of
stationary equilibrium exist when with mass entrants there’s a stopping
rule, through which price of output and input has absorbed the shock
over time.
• Properties of stationary equilibrium:
• Depends on size distribution of firms by their age cohorts, size of firm
influences if inputs or output is an increasing function of shock,ϕ.
• Outlook of new firms towards the industry stated by proposition 3
• Proposition 4 explains about ordering of firms as per their dominance in
the industry will be likely to achieve stationary equilibrium.
• Proposition 5 to 8 explains even though there is an exit rule long-lived
larger firms will tend to remain larger before they exit.
• Findings: size distribution impacts the stationary equilibrium not the age,
but if there’s a temporary shock then age can effect.
• Higher cost of entry leads to a lower turnover rate. Higher cost of entry protects the
incumbent firms, also restricts mass entrants. This would bring higher profits for
larger firms not necessarily for smaller ones though.
• The increase in cost of entry, as a price effect and a selection effect, if input prices are
fixed the output increases as increases, leads to higher employment as well, but both
effects depends on process of shocks and the production function. This will create a
direct and indirect effect on stationary equilibrium, for direct effect if the firm keep
product prices same, new entrants will have lower distribution of profit, while indirect
effect if no. of firms exiting lowers it will create a stable system, which will increase
turnover rate since profit function is separable in the state of firm and market prices.
• If the number of new firm increases, market share of entrants falls iff is fixed hence
there will be a stationary equilibrium.
• Considering two industries, with fixed , one lower than the other, it is
observed in this study that even though firms are attracted towards
lower industry but expected discounted profit in the other
market(with higher ) is higher hence firms choose that industry. Thus
the results are paradoxical in empirical analysis. Only with
compensation in to the entrants in first industry can change the
effects as per equation 15 and 16.
• Gaps:
• Even though the study talks about economies of scale in proposition
6, but it does not explain about vertical or horizontal scaling.
• Product type is not correctly identified.
• Since the paper is almost 2 decades old, game plans of online market
places aren’t considered.