Ample evidence from micro data suggests that productivity at establishment level is dominated by idiosyncratic factors. The productivity differences across establishments are very large and persistent even with the narrowest definition of industries. There is an attempt to identify sources of frictions that cause such productivity dispersion and negatively affect the average productivity of industries. This dissertation contemplates a non-monotonic relationship between productivity and input size and studies its importance in shaping the relationship between productivity dispersion and the producer size, a fact that is presented along with supportive empirical results. The role of market structure is then elaborated in creating the observed behavior.

The US Census of Manufactures reveals significant productivity dispersion at any employment level. Moreover, this productivity dispersion falls with employment size within most manufacturing industries. This pattern is considerably strong for establishments in industries whose products are primarily locally traded. It will be shown that general approaches such as industry selection and simple statistical aggregation do not explain this pattern convincingly, while sector-specific factors such as market localization can mimic this behavior much more closely.

Based on these results, a market structure model is introduced that uses demand size and market localization as constraining forces to generate a bell-shaped relationship between input size and productivity within a market and for locally traded goods. The non-monotonicity of the relationship is a clear departure from most economic models where input size of plants is monotonically increasing with their productivity in the long-run. Because of the bell-shaped relationship, the proposed model predicts significant long-run productivity dispersion at any level of input size. Also this dispersion decreases with input size, in the same way as is observed in the data.

The model is calibrated and then simulated using data on Ready-Mix Concrete. First, the relationship between productivity and input size in the data is of a similar bell-shaped form. The effect of market size is also shown to be consistent with model predictions. Second, simulated results produce productivity dispersions that fall with input size with almost the same slope as observed in the data. This, in turn, suggests that the difference between simulated and actual productivity dispersions, summarizing the effect of other frictions, is almost uniform across sizes. Finally the robustness of the results is demonstrated through various tests.

Throughout the discussion, a distinction is made between physical and revenue productivities and the theoretical implications of both measures are shown to be qualitatively the same.