Abstract:

We show that the tension between entry and rents lies at the core of a general theory of aggregation with scale effects. We characterize the responses of macro aggregates to micro shocks in disaggregated economies with general forms of entry, internal or external returns to scale, input-output linkages, and distortions. In particular, we decompose changes in aggregate productivity into changes in technical and allocative efficiency, and show that the latter depend on changes in rents and quasi-rents across markets. In addition, we give formulas for the social costs of distortions. Finally, we prove that while first-best industrial policy is network-independent, second-best policy supports the more ``networked'' parts of the economy by boosting the backward linkages of markets with high forward linkages and returns to scale. As an application, we quantify the misallocation from markups in the U.S.: accounting for entry raises the aggregate efficiency loss from 20% to 40%. This number depends sensitively on how entry is modeled, in ways that we make precise.