DP3959 Product Choice and Product Switching

Author(s): Andrew B. Bernard, Stephen J. Redding, Peter K. Schott
Publication Date: July 2003
Keyword(s): entry and exit, heterogenous firms, product differentiation, sunk costs
JEL(s): D21, L11, L60
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=3959

This Paper develops a model of endogenous product selection by firms. The theory is motivated by new evidence we present on the importance of product switching by US manufacturers. Two-thirds of continuing firms change their product mix every five years, and product switches involve more than 40% of firm output and almost half of existing products. The theoretical model incorporates heterogeneous firms, heterogeneous products, and ongoing entry and exit. In equilibrium, firm productivity is correlated with product fixed costs, with the most productive firms choosing to make the products with the highest fixed costs. Changes in market structure result in systematic patterns of firm entry/exit and product switching.