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  • Eric Schmidbauer

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

Are new versions of products necessarily better? We analyze product innovation by a firm that engages in research and development designed to improve an existing product, the outcome of which is uncertain. If the firm adopts the innovation its modified product appears to consumers as new and improved, but consumers do not immediately know whether or how much the product is better. We find that new products are on average improved and therefore command a pricing premium. This induces some types to exploit the new product signal by selling new versions that are only trivially different from their older version or that require inefficiently high upgrade costs. Nevertheless, the incentive to show off by introducing a new product may improve total welfare by inducing more innovation adoption and thereby mitigating the standard monopoly underinvestment problem. Innovation signaling provides a rational explanation for consumer attraction to new versions of products without resort to behavioral assumptions such as a preference for "newness".

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File URL: http://www.bus.indiana.edu/riharbau/RePEc/iuk/wpaper/bepp2013-01-schmidbauer.pdf
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Bibliographic Info

Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2013-01.

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Date of creation: Jan 2013
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Handle: RePEc:iuk:wpaper:2013-01

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Related research

Keywords: Asymmetric information; Signaling; Innovation;

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  1. Midgley, David F & Dowling, Grahame R, 1978. " Innovativeness: The Concept and Its Measurement," Journal of Consumer Research, University of Chicago Press, vol. 4(4), pages 229-42, March.
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  10. Bagwell, Kyle & Riordan, Michael H, 1991. "High and Declining Prices Signal Product Quality," American Economic Review, American Economic Association, vol. 81(1), pages 224-39, March.
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  13. Hirschman, Elizabeth C., 1984. "Experience seeking: A subjectivist perspective of consumption," Journal of Business Research, Elsevier, vol. 12(1), pages 115-136, March.
  14. Linnemer, Laurent, 2002. "Price and advertising as signals of quality when some consumers are informed," International Journal of Industrial Organization, Elsevier, vol. 20(7), pages 931-947, September.
  15. Yaron Yehezkel, 2008. "Signaling Quality in an Oligopoly When Some Consumers Are Informed," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(4), pages 937-972, December.
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