On the Simultaneity of Innovations and Market Structure

This paper examines the determinants of innovations and market structure within a simulta­ neous framework. From a competitive fringe model, quasi-conditional factor demand functions are derived that explain product and process innovations in terms of factor prices and market structure variables such as relative firm size, market size, and the concentration ratio where the latter set of vari­ ables result from the same optimizing process. Empirical evidence is gained from a cross section of 2276 West German firms in the manufacturing sector. In contrast to many other empirical studies, product and process innovations are measured by two dichotomous variables. An exogeneity test for the probit model is worked out and the conditional maximum likelihood estimator that emerges from this test is applied. The results show that simultanei­ ty does matter, even if innovations are explained by market structure variables at the firm level. Ac­ counting for endogeneity and cross-equation restrictions changes the results substantially.