Industry Dynamics With Stochastic Demand

We study the dynamics of an industry subject to aggregatedemand shocks where the productivity of a firm's technology evolvesstochastically over time. Each period, each firm, given the aggregatedemand shock, the productivity of its technology, and the distributionof technology productivities in the economy, (i) chooses whether toremain in the industry or to exit to sell its resources to an entrant;and (ii) an active firm chooses how much capital and labor to employ,and hence output to produce. To characterize the intertemporalevolution of the distribution of firms, we discuss in particular how exit decisions, aggregate output, profits and distributions offirm productivities vary, (a) across different demandrealization paths; (b) along a demand history path, detailingthe effects of continued good or bad market conditions; and (c) fordifferent anticipated future market conditions. Sufficient conditions are provide for worse demand realizations to lead toincreased exit of low-productivity firms and then to improveddistributions of firms at all future dates and states. Finally, it is shown that a downturn in demand can raise welfare due to the impact on exit decisions.