Chapter 5: The Schumpeterian Model

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Chapter 5: The Schumpeterian Model Philippe AghionUfuk AkcigitPeter HowittMay 21, IntroductionThis Chapter develops an alternative Model of endogenous growth, in which growth is generatedby a random sequence of quality-improving (or vertical ) innovations. The Model grew out ofmodern industrial organization theory1, which portrays innovation as an important dimension ofindustrial competition. This Model isSchumpeterianin that:(i)it is about growth generated byinnovations;(ii)innovations result from entrepreneurial investments that are themselves motivatedby the prospects of monopoly rents; and(iii)new innovations replace old technologies: in otherwords, growth involvescreative the past 25 years,2Schumpeterian growth theory has developed into an integrated frame-work for understanding not only the macroeconomic structure of growth but also the many mi-croeconomic issues regarding incentives, policies and organizations that interact with growth: whogains and who loses from innovations, and what the net rents from innovation are; these ultimatelydepend on characteristics such as property right protection, competition and openness, education,democracy and so forth and to a di erent extent in countries or sectors at di erent stages of de-velopment.

5.2.3 Solving the model The model is solved by backward induction: in each period t;we –rst compute the equilibrium production and pro–t of a successful innovator; then, we move back one step and compute the optimal innovation intensity by the –rm selected to be an innovator. 5.2.3.1 Equilibrium production and pro–ts We start from step 4.

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