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Entry and Innovation in Vertically Differentiated Markets

This paper analyzes the optimal entry into experience goods markets with vertically differentiated buyers. We consider the case where the value of the new product is imperfectly known, but common to all buyers (common values) as well as the case where the quality is different across buyers (private values). We distinguish between new products that are improvements to existing products and new products that are substitutes. Different types of products have qualitatively distinct diffusion paths. Improvements are introduced slowly relative to the full information case, while substitutes are introduced more aggressively. The slow entry strategy is associated with increasing supply and decreasing prices over time. The reverse pattern holds for an aggressive entry strategy The incentives to innovate display a similar distinction. A firm with a currently inferior product opts for a large but risky innovation, whereas a currently superior producer chooses a smaller but certain innovation.

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File URL: http://cowles.econ.yale.edu/P/cd/d12a/d1226.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1226.

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Length: 51 pages
Date of creation: Jun 1999
Date of revision:
Handle: RePEc:cwl:cwldpp:1226
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
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Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. 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.
  2. Dirk Bergemann & Juuso Valimaki, 1996. "Market Diffusion with Two-Sided Learning," Cowles Foundation Discussion Papers 1138, Cowles Foundation for Research in Economics, Yale University.
  3. Prescott, Edward C, 1972. "The Multi-Period Control Problem Under Uncertainty," Econometrica, Econometric Society, vol. 40(6), pages 1043-58, November.
  4. Grossman, G.M. & Helpman, E., 1989. "Quality Ledders In The Theory Of Growth," Papers 148, Princeton, Woodrow Wilson School - Public and International Affairs.
  5. Mirman, L.J. & Samuelson, L. & Urbano, A., 1989. "Monopoly Experimentation," Papers 8-89-7, Pennsylvania State - Department of Economics.
    • Mirman, Leonard J & Samuelson, Larry & Urbano, Amparo, 1993. "Monopoly Experimentation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(3), pages 549-63, August.
  6. Rothschild, Michael, 1974. "A two-armed bandit theory of market pricing," Journal of Economic Theory, Elsevier, vol. 9(2), pages 185-202, October.
  7. Godfrey Keller & Sven Rady, 1999. "Market experimentation in a dynamic differentiated-goods duopoly," LSE Research Online Documents on Economics 19346, London School of Economics and Political Science, LSE Library.
  8. Aghion, P. & Howitt, P., 1989. "A Model Of Growth Through Creative Destruction," UWO Department of Economics Working Papers 8904, University of Western Ontario, Department of Economics.
  9. Judd, Kenneth L & Riordan, Michael H, 1994. "Price and Quality in a New Product Monopoly," Review of Economic Studies, Wiley Blackwell, vol. 61(4), pages 773-89, October.
  10. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  11. Aghion, Philippe & Harris, Christopher & Vickers, John, 1997. "Competition and growth with step-by-step innovation: An example," European Economic Review, Elsevier, vol. 41(3-5), pages 771-782, April.
  12. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
  13. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  14. GABSZEWICZ, Jean J. & THISSE, Jacques-François, . "Entry (and exit) in a differentiated industry," CORE Discussion Papers RP -400, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  15. Harrington Jr. , Joseph E., 1995. "Experimentation and Learning in a Differentiated-Products Duopoly," Journal of Economic Theory, Elsevier, vol. 66(1), pages 275-288, June.
  16. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  17. Aghion, Philippe & Howitt, Peter, 1992. "A Model of Growth Through Creative Destruction," Scholarly Articles 12490578, Harvard University Department of Economics.
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