I model optimal product-market competition policy when industries differ in the potential for quality-improving technological advance. In a two- period model, a competition authority with limited resources administers a deterrence-based competition policy toward two industries. In one of the industries, an incumbent firm chooses the level of resources to invest in a quality-improving R&D project. In the other industry, product quality is constant. The competition authority cannot commit in advance to the toughness of competition policy in the post-discovery world. Optimal policy requires the competition authority to administer a tougher competition policy before innovation, all else equal, the greater the potential quality improvement; patent protection may increase R&D intensity, but worsens market performance.
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