1. Filson (2001) Previous research establishes that in new industries, price falls, market output rises, and the number of firms initially rises and then falls Most authors attribute these trends to innovations that occur at the industry level in new industries We still lack knowledge about the relative importance of different types of innovations Conventional wisdom is as described by Klepper (1996): product innovations are initially more important than process innovations, and later on process innovations are more important This conclusion is based mainly on the early automobile industry and other “old” industries Does it hold for recent high-tech industries? What are the implications for profitability?

2. Method Estimate trends in innovation using a dynamic model of industry evolution Why use a model? Because it is difficult to measure innovation directly The model relies on the following reasoning: if the trends in n (the number of firms), p (the average price), q (the market output), and s (the average quality) are due to industry specific innovation then we should be able to use data on n, p, q, and s to estimate the innovations The model employs flexible quality and cost ladders; firms take these as given and make entry, exit, output, and investment decisions optimally Given the ladders and the firm choices, the model generates series for n, p, q, s, and these can be fitted to data

3. Industries Automobiles 1895-1929 Personal Computers 1975-99 Rigid Disk Drives 1980-99 Computer Monitors 1971-99 Computer Printers 1970-99

4. Conclusions 1.The automobile industry is the only one whose pattern of innovation matches conventional wisdom (quality innovation followed by cost innovation); in the other industries cost innovation follows a variety of patterns and the rate of quality improvement does not diminish over time 2.Further, the results from the automobile industry show that knowing the rate of innovation is not sufficient for determining the profitability of innovation; profitability of quality innovation is higher late in the life cycle when the rate of quality improvement is lower. This occurs because firms are larger so any given markup is applied to more units of output

5. The Model There is a single industry, discrete time, an infinite horizon, and a continuum of firms The industry has a quality ladder and a cost ladder (the cost ladder includes a variable cost parameter-fixed cost parameter pair) Each period each firm invests in an attempt to be a leader on each ladder; the probability of success is a function of investment Simplifying assumptions: 1.All followers catch up to the leaders on each ladder at the end of each period 2.All firms have the same probability of success functions for innovation

6. Evolution Initially all firms are on the first rung on each ladder so all have the same quality , variable cost parameter a, and fixed cost f In the first period firms invest in an attempt to move to the 2 nd rung on each ladder In the second period and every subsequent one, there are two relevant rungs on each ladder; there are leaders and followers

7. The Firm’s Problem

8. Investment

9. Firm Value

10. Market Supply

11. The Consumer’s Problem and Market Demand

12. Equilibrium

13. Computation

14. Some Useful Simple Math

15. Computation Method