Knowledge that Transforms

[We present a model suggesting that innovative output is influenced by R&D and market structure characteristics. Based on a new and direct measure of innovation, we find that (1) the total number of innovations is negatively related to concentration and unionization, and positively related to R&D, skilled labor, and the degree to which large firms comprise the industry; and (2) these determinants have disparate effects on large and small firms.]

Using Tobin's q as a measure of performance, we seek to estimate the relative importance of industry, focus, and share effects in determining firm performance. Our methods are analogous to those of Richard Schmalensee and, like him, we find that industry effects account for the majority of the explained variance. However, we also find that firm effects exist in the form of focus effects, that is, narrowly diversified firms do better than widely diversified firms. We interpret this finding as consistent with profit maximization by firms with different factor endowments.

Many Keynesian macroeconomic models are based on the assumption that firms change prices at different times. This paper presents an explanation for this "staggered" price setting. We develop a model in which firms have imperfect knowledge of the current state of the economy and gain information by observing the prices set by others. This gives each firm an incentive to set its price shortly after other firms set theirs. Staggering can be the equilibrium outcome. In addition, the information gains can make staggering socially optimal even though it increases aggregate fluctuations.