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Economics of Networks

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, International 10
Hosted By: American Economic Association
  • Chair: Stephen James Redding, Princeton University

Endogenous Production Networks

Daron Acemoglu
Massachusetts Institute of Technology
Pablo Azar
Massachusetts Institute of Technology


We develop a tractable model of endogenous production networks. Each one of a number of products can be produced by combining labor and an endogenous subset of the other products as inputs. Different combinations of inputs generate (prespecified) levels of productivity. Markets are “contestable” in the sense that production technologies are available to a large number of potential producers. We establish the existence and uniqueness of an equilibrium with an endogenous production network and provide comparative static results on how prices and endogenous technology choices (and thus the production network) respond to changes in parameters. These results show that improvements in technology (or reductions in distortions) spread throughout the economy via input-output linkages and reduce all prices, and under reasonable restrictions on the menu of production technologies, also lead to a denser production network. Using a dynamic version of the model, we show that the endogenous evolution of the production network could be a powerful force towards sustained economic growth. At the root of this result is the fact that the arrival of a few new products expands the set of technological possibilities of all existing industries by a large amount — that is, if there are n products, the arrival of one more new product increases the combinations of inputs that each existing product can use from 2^(n−1) to 2^n, thus enabling significantly more pronounced cost reductions from the choice of optimal technology combinations. These cost reductions then spread to other industries that benefit from lower input prices and are further incentivized to adopt additional inputs.

Misallocation in the Market for Inputs: Enforcement and the Organization of Production

Johannes Boehm
Sciences Po
Ezra Oberfield
Princeton University


The strength of contract enforcement determines how firms source inputs and organize production. Using microdata on Indian manufacturing plants, we show that production and sourcing decisions appear systematically distorted in states with weaker enforcement. Specifically, we document that in industries that tend to rely more heavily on relationship-specific intermediate inputs, plants in states with more congested courts shift their expenditures away from intermediate inputs and appear to be more vertically integrated. To quantify the impact of these distortions on aggregate productivity, we construct a model in which plants have several ways of producing, each with different bundles of inputs. Weak enforcement exacerbates a holdup problem that arises when using inputs that require customization, distorting both the intensive and extensive margins of input use. The equilibrium organization of production and the network structure of input-output linkages arise endogenously from the producers' simultaneous cost minimization decisions. We identify the structural parameters that govern enforcement frictions from cross-state variation in the first moments of producers' cost shares. A set of counterfactuals show that enforcement frictions lower aggregate productivity to an extent that is relevant on the macro scale.

Cascades and Fluctuations in an Economy with an Endogenous Production Network

Mathieu Taschereau-Dumouchel
Cornell University


This paper proposes a simple theory of production in which the network of input-output linkages is endogenously determined by the decision of the firms to operate or not. Since producers benefit from having multiple suppliers, the economy features complementarities between the operating decisions of nearby firms. As a result, tightly connected clusters of producers emerge around productive firms. In addition, after a firm is hit by a severe shock, a cascade of shutdowns might spread from neighbor to neighbor as the network reorganizes itself. While well-connected firms are better able to withstand shocks, they trigger larger cascades upon shut down, a prediction confirmed by U.S. data. The theory also predicts how the shape of the network interacts with the business cycle. As in the data, periods of low economic activity feature less clustering among firms, and are associated with thinner tails for the degree distributions. Finally, allowing the network to reorganize itself in response to idiosyncratic shocks leads to substantially smaller variations in aggregate output, suggesting that endogenous changes in the shape of the production network have a significant impact on the aggregation of microeconomic shocks into macroeconomic fluctuations.
JEL Classifications
  • E1 - General Aggregative Models
  • D2 - Production and Organizations