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CEP discussion paper
Product Choice and Product Switching
Andrew B. Bernard, Stephen J. Redding and Peter K. Schott
November 2003
Paper No' CEPDP0594:
Full Paper (pdf)

JEL Classification: L11; D21; L60

Tags: heterogeneous firms; product differentiation; sunk costs; entry and exit

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 U.S. 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.