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New goods and the size distribution of firms

  • Erzo G.J. Luttmer

This paper describes a simple model of aggregate and firm growth based on the introduction of new goods. An incumbent firm can combine labor with blueprints for goods it already produces to develop new blueprints. Every worker in the economy is also a potential entrepreneur who can design a new blueprint from scratch and set up a new firm. The implied firm size distribution closely matches the fat tail observed in the data when the marginal entrepreneur is far out in the tail of the entrepreneurial skill distribution. The model produces a variance of firm growth that declines with size. But the decline is more rapid than suggested by the evidence. The model also predicts a new-firm entry rate equal to only 2.5% per annum, instead of the observed rate of 10% in U.S. data.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 649.

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Date of creation: 2007
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Handle: RePEc:fip:fedmwp:649
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  1. Klette, Tor Jakob & Kortum, Samuel S, 2002. "Innovating Firms and Aggregate Innovation," CEPR Discussion Papers 3248, C.E.P.R. Discussion Papers.
  2. Thomas J. Holmes & James A. Schmitz, Jr., 1995. "On the turnover of business firms and business managers," Working Papers 545, Federal Reserve Bank of Minneapolis.
  3. Andrew Atkeson & Ariel Burstein, 2010. "Innovation, firm dynamics, and international trade," Staff Report 444, Federal Reserve Bank of Minneapolis.
  4. Xavier Gabaix, 2009. "The Granular Origins of Aggregate Fluctuations," NBER Working Papers 15286, National Bureau of Economic Research, Inc.
  5. Rasmus Lentz & Dale T. Mortensen, 2005. "An Empirical Model of Growth Through Product Innovation," NBER Working Papers 11546, National Bureau of Economic Research, Inc.
  6. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  7. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  8. Satyajit Chatterjee & Esteban Rossi-Hansberg, 2008. "Spinoffs and the market for ideas," Working Papers 08-26, Federal Reserve Bank of Philadelphia.
  9. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
  10. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," NBER Working Papers 12365, National Bureau of Economic Research, Inc.
  11. Erzo G.J. Luttmer, 2006. "Consumer search and firm growth," Working Papers 645, Federal Reserve Bank of Minneapolis.
  12. Stephen Hymer & Peter Pashigian, 1962. "Firm Size and Rate of Growth," Journal of Political Economy, University of Chicago Press, vol. 70, pages 556.
  13. Burdett, Kenneth & Vishwanath, Tara, 1988. "Balanced Matching and Labor Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 1048-65, October.
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