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Optimal Growth Through Product Innovation

Author

Listed:
  • Dale T. Mortensen
  • Rasmus Lentz

    (University of Wisconsin-Madison)

Abstract

In Lentz et al. (2008), we formulate and estimate a market equilibrium model of endogenous growth through product innovation. In this paper, we provide quantitative equilibrium solutions to the model based on our parameter estimates, and compare them with a social planner's solution. We find that the socially optimal growth rate is double that of the market equilibrium growth rate when firm differences in the ability to create productive products are highly persistent as a consequence of the 'business stealing externality present in the model. The welfare loss of the decentralized economy relative to that of the planner is equivalent to a 20% tax on the planner consumption path. The planner's solution differs from the decentralized economy in that it discourages innovation by low ability innovators as well as entry. We introduce two mechanisms that temper the strength of the negative externality: Transitory firm types and the possibility of buyouts. We show that both sharply reduce the inefficiency due to innovation by low ability innovators. But with caveats: If firm types are completely transitory, then the notion of firm heterogeneity is for practical purposes lost. Buyouts improve efficiency, but the efficiency gain depends significantly on the strength of the innovator's ability to extract rents from incumbents through the buyout.

Suggested Citation

  • Dale T. Mortensen & Rasmus Lentz, 2015. "Optimal Growth Through Product Innovation," 2015 Meeting Papers 1025, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1025
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    References listed on IDEAS

    as
    1. Aghion, Philippe & Howitt, Peter, 1992. "A Model of Growth through Creative Destruction," Econometrica, Econometric Society, vol. 60(2), pages 323-351, March.
    2. William Kerr & Ufuk Akcigit & Nicholas Bloom & Daron Acemoglu, 2012. "Innovation, Reallocation and Growth," 2012 Meeting Papers 1137, Society for Economic Dynamics.
    3. Tor Jakob Klette & Samuel Kortum, 2004. "Innovating Firms and Aggregate Innovation," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 986-1018, October.
    4. Rasmus Lentz & Dale T. Mortensen, 2008. "An Empirical Model of Growth Through Product Innovation," Econometrica, Econometric Society, vol. 76(6), pages 1317-1373, November.
    5. Sigurd Mølster Galaasen & Alfonso Irarrazabal, 2016. "R&D heterogeneity and its implications for growth," Working Paper 2016/15, Norges Bank.
    6. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-1150, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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