Efficiency with Equilibrium Marginal Product Dispersion and Firm Selection

Julieta Caunedo (Cornell University) examines Efficiency with Equilibrium Marginal Product Dispersion and Firm Selection.

ABSTRACT: Disparities in revenue productivity for narrowly defined industries is ubiquitous in firm-level data. Whereas often times such a heterogeneity is a symptom of factor misallocation, it is also possible that part of it is induced by firms' optimal decisions under technology and information constraints. To date, there is limited understanding of the implications of the observed revenue product heterogeneity for efficiency in frameworks where both sources for dispersion coexist. This paper fills the gap. Market distortions that generate inefficient factor accumulation may feed back into the equilibrium distribution of revenue productivity, and hence, empirical measures of allocative efficiency. Understanding such interaction is key for policy design. In this paper, I focus on the study of market distortions generated by firms' market power and I generate endogenous revenue product dispersion through either heterogeneous market power, non-convex production technologies, or information frictions. I characterize the market decentralization of efficient outcomes via policies that do not require firm-level information. Most importantly, I show that the welfare gains for a wide class of models when implementing these optimal policies follows a common pattern: welfare gains are proportional to the change in average revenue product and the number of operating units in the market.