Innovations, Market Structure and Market Dynamics*

Innovative activity is considered to be an important source of structural change and growth by providing a flow of new products and cost-saving technical processes. Since the seminal work of Schumpeter [1942] numerous empirical studies, and more recently, theoretical models have been published, analyzing the relationships between market structure and innovative activity. In Capitalism, Socialism, and Democracy , Schumpeter argued strongly that "in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largestscale unit of control for instance) competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the output of the existing firms but at their foundations and their very lives"1. Although Schumpeter did not deny the usefulness of the static theory of competition, he conjectured that inefficiency (in the static sense) was more than offset by the increase in the rate of productivity promoted by the largescale monopoly firm. Two main hypothesis usually attributed to Schumpeter, though the second has been stressed more by Galbraith [1952] emerged from this reasonsing:2 (1) there is a positive relationship between innovation and monopoly power, and (2) large firms are more than proportionately more innovative than small firms. Although in most empirical studies this relationship has been analyzed by taking some measure of monopoly power or concentration ratio as an independent variable, it has been recognized that both are endogenous variables: monopoly power with the concomitant above-normal profits provides