Product innovation incentives: Monopoly vs. Competition. Working paper

Arrow (1962) showed that a secure monopolist (unconcerned with preemption) has a weaker incentive than would a competitive \u85rm to invest in a patentable process innovation. This paper shows that the ranking can be reversed for product innovations. Only the innovator sells the new product, a di¤erentiated substitute for the old. Under alternative market structures considered, the old product is sold only by that same \u85rm (two-product monopoly), only by a di¤erent \u85rm (post-innovation duopoly), or in perfect competition. In an asymmetric Hotelling model, the innovation incentive under monopoly is greater than under duopoly if and only if the new product has the higher quality, and is always greater than under perfect competition