A Closed Economy Model of Horizontal and Vertical Product Differentiation: The Case of Innovation in Biotechnology

In endogenous growth theory models have either increasing or constant ranges of product variety. Developments in modem biotechnology however show cases of increasing, decreasing or constant ranges of product variants. We present a simple endogenous growth model allowing for all of these three cases in one model. Quality weights that are exponential in the index of goods are multiplied to the quantity of goods in a love-of-variety utility function. Consumers prefer not to buy goods which are too expensive relative to their quality. The presence or absence of cumulated knowledge determines whether licensing fees, endogenous fixed costs for and the number of producers and the quantities produced are falling or constant, thereby allowing more or less room for variety in household budgets. Whereas new goods always appear, old goods may be selected away or are even reselected. The case of pure love-of-variety and total creative destruction are limiting cases in this model and cases of decreasing variety or initially increasing and later decreasing variety are additions to the present literature. The highly non-linear dynamics of the model are presented in simulations.