On the Relationship between Competition and Innovation in a Duopoly with a Single Innovator

This paper studies the incentive by a single firm in a differentiated goods duopoly to engage in cost-reducing innovations and how this incentive is affected by the level of competition in the product market. It is found that a firm's innovation effort has a U-shaped relationship with the level of competition. This result generally holds true for both the initially more efficient firm and the initially less efficient firm and in both the open loop model and the closed loop model. Consumers always benefit from innovations and fare the best when the initially more efficient firm is the innovator.