Intra-Industry Dynamics with Heterogeneous Firms and Endogenous Product Choice: Theory and Evidence∗

This paper is about how firms choose products. Product changes are frequent events at US manufacturing plants. Over two thirds of surviving plants add and/or drop at least one product every five years. We develop a theoretical model that integrates endogenous product choice into a dynamic analysis of industry evolution with entry and exit and heterogeneous firms. In equilibrium, firm productivity is correlated with product-level fixed costs, with the most productive firms endogenously 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.