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Product Innovation Incentives: Monopoly vs. Competition


  • We thank Axel Anderson, Tim Brennan, Malcom Coate, Jim Dana, Andrew Daughety, Jorge Fernandez, Ian Gale, Richard Gilbert, Ed Green, David Malueg, Federico Mini, David Sappington, Daniel Vincent, Scott Wallsten, Greg Werden, Ralph Winter, anonymous referees, and the Editor for helpful discussions and comments.


In contrast to Arrow's result for process innovations, we show that the gain from a product innovation can be larger to a secure monopolist than to a rivalrous firm that would face competition from independent sellers of the old product. A monopolist incurs profit diversion from its old good but may gain more than a rivalrous firm on the new good by coordinating the prices. In a Hotelling framework, we find simple conditions for the monopolist's gain to be larger. We also explain why the ranking of innovation incentives differs under vertical product differentiation.