This paper provides a model of ﬁrm and industry dynamics that allows for entry, exit and ﬁrm-speciﬁc uncertainty generating variability in the fortunes of ﬁrms. It focuses on the impact of uncertainty arising from investment in research and exploration-type processes. It analyzes the behavior of individual ﬁrms exploring proﬁt opportunities in an evolving marketplace and derives optimal policies, including exit, in this environment. Then it adds an entry process and aggregates the optimal behavior of all ﬁrms, including potential entrants, into a rational expectations, Markov perfect industry equilibrium, and proves ergodicity of the equilibrium process. Numerical examples are used to illustrate the more detailed characteristics of the stochastic process generating industry structures that result from this equilibrium.
Ericson, Richard and Pakes, Ariel, "An Alternative Theory of Firm and Industry Dynamics" (1992). Cowles Foundation Discussion Papers. 1284.