Capacity Dynamics and Endogenous Asymmetries in Firm Size

Empirical evidence suggests that there are substantial and persistent differences in the sizes of firms in most industries. We propose a dynamic model of capacity accumulation that is consistent with the observed facts. The model highlights the mode of product market competition and the extent of investment reversibility as key determinants of the size distribution of firms in an industry. In particular, if firms compete in prices and the rate of depreciation is large, then the industry moves toward an outcome with one dominant firm and one small firm. Industry dynamics in this case resemble a preemption race. Contrary to the usual intuition, this preemption race becomes more brutal as investment becomes more reversible.