DP16522 The Neoclassical Model and the Welfare Costs of Selection

Author(s): Fabrice Collard, Omar Licandro
Publication Date: September 2021
Keyword(s): Capital irreversibility, Firm dynamics and selection, Investment distortions, Neoclassical Model, Transitional Dynamics, welfare gains
JEL(s): D6, E13, E23, O4
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16522

This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to solve for the transitional dynamics of economies moving towards more selection. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, the selection process generates transitional welfare losses that may reduce in around 60% long term (consumption equivalent) welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.