Innovation by Entrants and Incumbents
Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Dan Vu Cao
Georgetown University - Department of Economics
September 12, 2010
MIT Department of Economics Working Paper No. 10-12
We extend the basic Schumpeterian endogenous growth model by allowing incumbents to undertake innovations to improve their products, while entrants engage in more “radical” innovations to replace incumbents. Our model provides a tractable framework for the analysis of growth driven by both entry of new firms and productivity improvements by continuing firms. Unlike in the basic Schumpeterian models, subsidies to potential entrants might decrease economic growth because they discourage productivity improvements by incumbents in response to reduced entry, which may outweigh the positive effect of greater creative destruction. As the model features entry of new firms and expansion and exit of existing firms, it also generates a non-degenerate equilibrium firm size distribution. We show that when there is also costly imitation preventing any sector from falling too far below the average, the stationary firm size distribution is Pareto with an exponent approximately equal to one (the so-called “Zipf” distribution”).
Number of Pages in PDF File: 57
Keywords: Innovation, Entrants, Incumbents
JEL Classification: O30, O31, O33, L11
Date posted: September 24, 2010
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