Endogenous business cycles with small and large firms

Abstract

Recent decades have seen a rise in the market power of large firms. We propose a theory in which their technology involves the ability to produce multiple products. Large firms interact with smaller competitors and market share reallocations via product creation generate heterogeneous markup dynamics across the firm types. Higher market shares of large firms increase the parameter space for macroeconomic indeterminacy. Bayesian estimation of the general equilibrium model suggests the importance of the endogenous amplification of the product creation channel and animal spirits play a non-trivial role in driving U.S. business cycles.