Entry vs. Rents: Aggregation with Economies of Scale

We characterize the response of aggregate output to micro shocks in disaggregated economies with entry, non-constant returns to scale, input-output linkages, and distortions. We decompose output changes into technical and allocative efficiency components, and show that the latter depends on changes in rents and quasi-rents across markets. We use this to characterize the social costs of distortions and show the importance of accounting for entry both qualitatively and quantitatively. As an example, we show that the efficiency losses caused by markups in the US rise from around 20% of GDP to around 40% once we account for the entry margin. Our base-line is sensitive not only to the presence of entry, but also to the specifics of how entry is modeled, in ways that our social-costs-of-distortions formulas clarify. Entry can substantively alter the economy’s response to shocks even if variable profits and fixed costs are small as a share of GDP.