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New and Improved?

Author

Listed:
  • 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".

Suggested Citation

  • Eric Schmidbauer, 2013. "New and Improved?," Working Papers 2013-01, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    • Handle: RePEc:iuk:wpaper:2013-01
    as

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    File URL: http://kelley.iu.edu/riharbau/RePEc/iuk/wpaper/bepp2013-01-schmidbauer.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Asymmetric information; Signaling; Innovation;
    All these keywords.

    JEL classification:

    • L0 - Industrial Organization - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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