Product Innovation Incentives: Monopoly vs. Competition

Unlike Arrow’s result for process innovations, the gain from a product innovation can be larger to a secure monopolist than to a rivalrous …rm that would face competition from independent sellers of the old product. A monopolist incurs pro…t diversion from its old good but may gain more than a rivalrous …rm on the new good by coordinating the prices. In a Hotelling framework, we …nd simple conditions for the monopolist’s gain to be larger. We explain why the ranking of incentives di¤ers under vertical product di¤erentiation and suggest a principle that may determine the ranking for additional demand systems. Chen: Department of Economics, University of Colorado, Boulder, CO 80309 . Schwartz: Department of Economics, Georgetown University, Washington DC 20057 . We thank Axel Anderson, Andrew Daughety, Ian Gale, Richard Gilbert, Ed Green, David Malueg, Federico Mini, David Sappington, Daniel Vincent, and Ralph Winter for helpful discussions and comments.