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New and Improved?

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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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Keywords: Asymmetric information; Signaling; Innovation;

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  1. Mark Armstrong & John Vickers & Jidong Zhou, 2009. "Prominence and consumer search," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 209-233.
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