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Recent empirical evidence based on firm level data emphasizes firm heterogeneity in innovation activities and the different effects of process and product innovations on the productivity level and productivity growth. To match this evidence, this paper develops an endogenous growth model with two sources of firm heterogeneity: production efficiency and product quality. Both attributes evolve endogenously through firms' innovation choices. Growth is driven by innovation and self-selection of firms and sustained by entrants who imitate incumbents.
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