Supply Network Formation and Fragility
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We model the production of complex goods in a large supply network. Firms source several essential inputs through relationships with other firms. Relationships may fail, and given this idosyncratic risk, firms multisource inputs and make costly investments to make relationships with suppliers stronger (less likely to fail). We find that aggregate production is discontinuous in the strength of these relationships. This has stark implications for equilibrium outcomes. We give conditions under which the supply network is endogenously fragile, so that arbitrarily small negative shocks to relationship strength lead to a large, discontinuous drop in aggregate output.
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