Industry Dynamics and Efficiency with Endogenous Entry and Exit

Paper explores the effect of free entry on aggregate welfare in the perfectly competitive homogeneous good industry with heterogeneous firms, endogenous entry and exit and with business cycle dynamics driven by purely firm-specic technological shocks. I extend the model of industry dynamics proposed by Hopenhayn by putting it in the general equilibrium settings and relaxing the assumption of continuum of technological levels. Using MATLAB I solve numerically for competitive and constraint efficient outcomes. Results show that pecuniary externalities appear in the economy through the wage rate. In competitive equilibrium wage rate depends on the productivity of the marginal entrant and not on the average productivity of the industry. Competitive equilibrium results in insufficient level of entry and in such exit rule when relatively inefficient incumbents stay in the industry. Social planner by selecting appropriate mass of entrants and exit rule can select higher average productivity level. As a result, aggregate income and consumption are higher. Policy of subsidizing entrants' variable labor costs allows to achieve outcome superior to the competitive one, although deadweight losses arise due to labor market distortions. Policy of changing the bankruptcy code allows to achieve socially efficient level of welfare.