Pricing under innovation

Abstract

We study pricing when firms introduce process and product innovations over time. We set up a model of endogenous productivity and markup under imperfect competition and dynamic pricing. We estimate it using output price indices reported by an unbalanced panel of 2,300 Spanish manufacturing firms during 1990-2006. Markups turn out to be procyclical and change with the introduction of innovations. Firms use innovation to increase margins, but product innovators are careful to raise prices on new or improved goods. Process innovations tend to leave prices unchanged, product innovations tend to raise prices and firms that introduce both tend to decrease them