Wages and productivity growth in a dynamic monopoly

This paper studies the intertemporal problem of a monopolistic firm that engages in productivity enhancing innovations to reduce labor costs. The optimal innovation policy is not monotone and the rate of productivity growth is the highest when the firm's size is in some intermediate range. As long as its initial productivity is not too low, the firm eventually reaches a steady state where the rate of productivity growth is identical to the rate of wage growth. Productivity dependent wage differentials do not affect productivity growth in the steady state; they increase, however, the firm's long-run equilibrium cost level. (C) 2003 Elsevier B.V. All rights reserved.