Learning and firm dynamics in a stochastic equilibrium

Abstract

New firms have unknown profitability types, but they learn in the market. With imperfect information, the learning mechanism matters at the firm level and in the aggregate. This paper studies the effect of learning on the distribution of firms, aggregate dynamics, and welfare when firm growth and the entry and exit dynamics are belief-driven. Aggregate uncertainty affects heterogeneous firm beliefs about own types. Faster learning raises firms' continuation values, lowers the selection threshold belief, and thickens the belief distribution's right tail. Aggregate uncertainty lowers firm value by reducing firms' learning speed. Transitory aggregate shocks have persistent impacts on the economy by shifting existing firms' belief updating paths, affecting firm decisions along both intensive and extensive margins. Faster learning improves social welfare.