Investment, Externalities and Industry Dynamics (Very preliminary and incomplete)

ABSTRACT. We provide an alternative theoretical explanation for a number of empirical regularities relating to the dynamics of industry structrure (prod-uct life cycle) and changes in size and age distribution of firms over time. We explain why entry may continue over a considerable period of time, why shake out of firms occur in mature industries and why exiting firms are likely to be younger and smaller in size than incumbents. Unlike the existing theoretical lit-erature, this explanation is not based on uncertainty, structural non-stationarity or incomplete information. We consider an infinite horizon, complete informa-tion, deterministic competitive industry with continuum of firms and stationary market demand. Firms have perfect foresight, may enter or exit the industry at any point of time and active firms undertake investment which reduces their future cost of production. Investment by active firms also leads to the growth of an industry-wide capital that reduces production cost of all firms (externality). The marginal cost curves are upward sloping and firms incur a fixed cost of staying in the industry. While all entering firms earn zero intertemporal ne