Supply Network Formation and Fragility

Document pages: 56 pages

Abstract: We model the production of complex goods in a large supply network. Each firmsources several essential inputs through relationships with other firms. Due tothe risk of such supply relationships being idiosyncratically disrupted, firmsmultisource inputs and strategically invest to make relationships withsuppliers stronger. Aggregate production is robust to idiosyncraticdisruptions. However, there is a regime in which equilibrium supply networksare fragile, with small aggregate shocks to relationships causing arbitrarilysteep drops in output. The endogenous configuration of supply networks providesa new channel for the powerful amplification of shocks.