A Model of Growth with the Size Distribution of Firms and Economies of Scale

The size distribution of firms in each industry will usually be highly skew, and empirical evidence shows that it is approximated closely by the Pareto distribution. In this paper we make an attempt to explain why the Pareto law applies to the size distribution of firms based on their innovation and investment behavior, and then develop a model of economic growth that take into account this empirical law. First, we show that the Pareto distribution of firms is generated under the assumption that firms acquire the technology of operating efficiently on a larger scale through learning by doing, and expand their scale of operation through the accumulation of capital induced by profitability. Then, we construct a model of economic growth that is based on the Pareto distribution of firms and economies of scale. In our model the growth rate is determined endogenously, and it exhibits scale effects with respect to savings. Our model is different from the neoclassical growth model or the recently developed endogenous growth models in that it takes into account the size distribution of firms, and it yields quite realistic predictions.