Firm dynamics with frictional product and labor markets

• Applicant: Professor Dr. Leo Kaas
• Subject Area: Economic Theory
• Term: from 2016 to 2018
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 310443373

The dynamics and heterogeneity of firms is of central importance for the understanding of aggregate outcomes, such as job flows and labor market policy, international trade, aggregate productivity dynamics and economic growth. Much of the existing literature on the role of firm heterogeneity and firm dynamics is based on dynamic and stochastic equilibrium models in which dispersion in firm size and variation in firm growth result from persistent productivity differences and transitory productivity shocks. Productivity is generally understood as revenue productivity which reflects both a firm's prices as well as its physical productivity. However, recent empirical literature points at a prominent role of firm-specific demand for firm growth and firm performance. Moreover, revenue productivity is less dispersed than physical productivity, because firm-level prices are negatively correlated with physical productivity. This project aims to examine the respective roles of firm-specific demand and physical productivity for firm dynamics and the labor market. The project has novel empirical and theoretical contributions. On the empirical side, we analyze official firm data for the manufacturing sector in Germany for which reliable price and quantity information for particular products, together with information on employment, working hours and wages, can be obtained. We are interested in the firm dynamics of prices and quantities and in their relationship with employment and wages. We also examine the nature of price dispersion and its connection with firm characteristics. On the theoretical side, we build an equilibrium model in which heterogeneous firms compete for workers in a frictional labor market and simultaneously compete for buyers in a frictional product market. In this model, prices and wages are dispersed across firms, and technology and demand shocks have distinct implications for the employment, wage, output and price policies of firms. Our goal is to calibrate this model to suitably account for the firm dynamics observed in German firm-level data, so that it can be used for several counterfactual experiments.

• DFG Programme: Research Grants