Investment , Externalities and Industry Dynamics ( Preliminary , Incomplete )

We provide an alternative theoretical foundation for a number of well known empirical regularities on industry dynamics and product life cycle. We consider a dynamic competitive industry with free entry and exit and time stationary demand where all firms are ex ante identical, have perfect foresight and where there is no uncertainty or information problem. We show that when firms invest in deterministic future cost reduction and investment confers positive externalities on other firms, the industry equilibrium path may be characterized by heterogeneity in size and performance of firms, dispersed entry over time, shake out in mature industries, better survival and profitability of larger and older firms, long-run convergence of industry structure and long-run persistence of positive profits. Entry may continue over time in the industry if investment is relatively more effective is reducing fixed cost and the externality effect is strong. Shake-out of firms occurs when investment is relatively more effective in reducing marginal cost and demand is sufficiently inelastic. Older firms accumulate more capital and therefore, produce more output and are less likely to exit.