Abstract

Recent empirical evidence provided by Bernard et al. (2010) and Broda and Weinstein (2010) shows that a significant share of product creation and destruction in U.S. industries occurs within existing firms and accounts for a significant share of aggregate output. In the present paper, and consistent with this evidence, we relax the standard assumption of mono-product firms that is typically made in dynamic general equilibrium (DSGE) models. We develop a DSGE model with multi-product firms and endogenous markups to assess the implica- tions of the intra-firm extensive margin on business cycle fluctuations. In this environment, the procyclicality of product creation emerges as a consequence of firms’ strategic interactions. Due to the proliferation effect in- duced by firm-level adjustments in product scope, we show that our model embodies a quantitatively important magnification mechanism of aggregate shocks.