(Static) Efficiency of the competitive equilibrium Each firm sets the efficient output level: p = MC The set of firm that are active in the long run equilibrium is efficient: free entry induces firms to produce a long-run output such that p = ACmin (Efficiency with the technology as given)

Implications of the standard model for entry, exit, firm size, … LR equilibrium is reached by a process of entry and exit. If there are profits in an industry, new firms enter. If existing firms make losses, there will be exit from the industry. In the LR eq. entry – exist stops, existing firms make 0-supra normal profit.

Implications of the standard model, continued If the plant level cost functions are U-shaped, all plants must be of the same size in the LR eq.   If owning multi-plants is costly (managerial costs) then all firms will be single plant firms. Without managerial costs, there is indeterminacy: any size distribution is possible. If there are economies of scale in multi-plant firms (Large scale purchasing discounts) that counteract managerial costs, we are back to U-shaped cost curves and all firms will have the same number of plants.

Empirical evidence from industries with many small firms Exit and entry occur simultaneously Gross entry and gross exit rates are much higher than (about ten times greater) the net entry rate. Many firms make supra normal profits in the LR Size distribution of firms displays number of regularities and is not concentrated on a single firm size

Entry and Exit Occur simultaneously: gross entry / exit rates are 10 times larger than net entry / exit rates. Entrants and exiters are much smaller than the average firm in the industry. See John Cable and Joachim Schwalbach (1991) “International Comparisons of Entry and Exit”, in Paul Geroski and Joachim Schwalbach (eds.) Entry and market contestability : Entrants sizes are between 6.7 % in US 44.5 % in UK, Exiters between 6.9 % in US 62.2 % in UK Expected growth rates are decreasing in size and age : that means that smaller firms grow faster than large firms, younger firms grow faster than the older firms. But it is mainly young and small firms that exit.

Firm size distribution Firm distribution is non-degenerate : it is skewed, there are many small firms and a few large firms: Log normal or Pareto distribution (see the next page for the graph of the distribution) Robust across many market definitions, industries, and aggregation (first noted by Herbert Simon & Bonini,1958) Fits well for almost any 500 fortune company

Normal LogNormal

From Simon and Bonini, (1958), “The size distribution of business firms”

Dennis Mueller (1986) “Profits in the Long Run” Main result : large differences in profitability across firms exist over long periods of time

One more time, the stylized facts about competitive markets Persistence of profits in the long run Entry and exit take place simultaneously Size of entrants and exiters smaller than industry average size Firms different size but regularities in the firm size distribution

Gibrat’s Law The French economist Robert Gibrat, in his book Inégalités Économiques (1931), proposed a basic model of firm growth and industry structure. Gibrat's model is very simple : There is no profit maximization attempts to form cartels, no firm has an advantage over the others. All is based on chance elements : It is assumed that during each period (month, quarter, year, ), the growth rate of each firm is an independent (across firms and across time periods), and identically distributed random variable.

Gibrat, continued Suppose there are 20 firms in an industry each with 5 % market share. During each period, each firm experiences a random growth rate of between −20% and +30% (with a uniform distribution). For any given firm, the growth rate in any period is independent from the growth rate of the preceding period, it is also independent of the size of the firm.   What happens to market structure, as measured by the Herfindahl-Hirschman index as time goes by? For this go to website http://www.unclaw.com/chin/teaching/antitrust/gibrat.htm

Gibrat’s Law [from http://www.unclaw.com/chin/teaching/antitrust/gibrat.htm ] One of the main issues in IO is : How do firms acquire and maintain market power? The idea is that it may simply be the consequence of historic accident. The French economist Robert Gibrat, in his book Inégalités Économiques (1931), proposed a super simple model of firm growth and industry structure that continues to receive scholarly attention even today in the IO literature. Gibrat's model is based on the assumption that during each period, the growth rate for each firm in a market is an independent, identically distributed random variable. (Is this assumption realistic? See John Sutton, Gibrat's Legacy, 35 J. ECON. LIT. 40 (1997).)