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Supply Network Formation and Fragility

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Document pages: 52 pages

Abstract: We model the production of complex goods in a large supply network. Each firmsources several essential inputs through relationships with other firms.Individual supply relationships are at risk of idiosyncratic failure, whichthreatens to disrupt production. To protect against this, firms multisourceinputs and strategically invest to make relationships stronger, trading off thecost of investment against the benefits of increased robustness. We find thatequilibrium aggregate production is robust to idiosyncratic disruptions.Nevertheless, there is a regime in which arbitrarily small systemic shockscause arbitrarily steep drops in output, so that the the supply network isfragile. The endogenous configuration of supply networks provides a new channelfor the powerful amplification of shocks.

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