Microeconomic Shock Propagation Through Production Networks in China

The question of whether microeconomic shocks induce aggregate fluctuations constitutes a central issue in economic research. This paper introduces a general equilibrium model with production networks to explore the propagation mechanisms of microeconomic shocks. A novel triangular production network structure is introduced, and simulations are performed using China’s input-output table to analyze the propagation of these shocks within the Chinese economy. The model demonstrates that the first-order effects of microeconomic shocks propagate downstream along the industrial chain, while the second-order effects of microeconomic productivity shocks propagate both upstream and downstream along the chain. The first-order propagation mechanism of microeconomic shocks involves changes in prices within the affected sector and its downstream sectors. Additionally, the second-order effects of microeconomic shocks rely on the reallocation of factors. The simulation results indicate that China’s production network matrix is triangular, and that the financial sector plays a crucial role in amplifying the effects of microeconomic shocks. Government should prioritize supporting upstream fundamental sectors to mitigate the adverse impacts of external shocks on economic fluctuations and to address systemic financial risks.