Part 4 of 7
Firm Heterogeneity
Span of control, monopolistic competition, variable markups, and misallocation.
We now focus on the firm problem and one of two main ways in which we can introduce firm heterogeneity into macroeconomic models. Technically, the impediment to meaningful firm heterogeneity lies in the combination of constant returns to scale and price-taking (or perfect competition) behavior. These features imply that the choices of all firms are scaled-versions of one-another, allowing for exact aggregation of firms into a representative firm. Departing from either of these features generates curvature in the firm's problem, making firms of different sizes behave differently. We go over the basics of each approach.