New Goods and the Size Distribution of Firms

This paper describes a simple model of aggregate and firm growth based on the introduction of new goods. An incumbent firm can combine labor with blueprints for goods it already produces to develop new blueprints. Every worker in the economy is also a potential entrepreneur who can design a new blueprint from scratch and set up a new firm. The implied firm size distribution closely matches the fat tail observed in the data when the marginal entrepreneur is far out in the tail of the entrepreneurial skill distribution. The model produces a variance of firm growth that declines with size. But the decline is more rapid than suggested by the evidence. The model also predicts a new-firm entry rate equal to only 2.5% per annum, instead of the observed rate of 10% in U.S. data. ∗Luttmer, University of Minnesota and Federal Reserve Bank of Minneapolis. This is a report on ongoing research. The second half of this paper mimics parts of Luttmer [2006b]. Comments welcome. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.