Productivity Shocks Diffusion in Firms Networks with Imperfect Competition and Bankruptcy

Abstract

The productive network represents a key economic mechanism to understand how microeconomic shocks spread in the economic system. At this scope, several theoretical works have been developed under the assumption of free competition, without considering market power or the possible bankruptcy of firms. This document studies the diffusion of productivity shocks in productive networks with imperfect competition and firms’ bankruptcy. It is assumed that firms can to set the price of their product, taking into account that prices affect the possibility of their buyers hiring them. This fact means that transactions could fail because, for instance, the products do not have the expected quality or characteristics, which would generate losses for the buyer. In this context, the buyer seeks not only the highest expected benefit, but also the lowest risk of loss, which leads him to assign a hiring probability to each supplier. On the other hand, firms’ bankruptcy is represented by a stochastic process in which firms with worse performance over time are more likely to leave the industry. The model’s results show different cascade effects on prices and quantities exchanged in the production network to negative productivity shocks. Interestingly, we observe an upstream cascade effect on firm bankruptcy over time, which is transmitted exclusively to suppliers with the lowest risk in the production network.