Consumer Search and Firm Growth

This paper presents a simple model of search and matching between consumers and firms. The firm size distribution has a Pareto-like right tail if the population of consumers grows at a positive rate and the mean rate at which incumbent firms gain customers is also positive. This happens in equilibrium when entry is sufficiently costly. As entry costs grow without bound, the size distribution approaches Zipf’s law. The slow rate at which the right tail of the size distribution decays and the 10% annual gross entry rate of new firms observed in the data suggest that more than a third of all consumers must switch from one firm to another during a given year. A substantially lower consumer switching rate can be inferred only if part of the observed firm entry rate is attributed to factors outside the model. The realized growth rates of large firms in the model are too smooth. ∗Luttmer, University of Minnesota and Federal Reserve Bank of Minneapolis. This is a report on ongoing research. Comments welcome. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.