MARKET-STRUCTURE, INNOVATION AND VERTICAL PRODUCT DIFFERENTIATION

We reassess Arrow's (1962) [Economic Welfare and the Allocation of Res ources for Invention, in NBER, The Rate and Direction of Innovative Ac tivity (Princeton University Press, Princeton NJ)] results concerning the effect of market structure on the returns from process innovation. Here we consider product innovations that are vertically differentiat ed from older products, in the sense of Shaked and Sutton (1982) (Rela xing Price Competition through Product Differentiation. Review of Econ omic Studies 49, 3-13.), Shaked and Sutton (1983) (Natural Oligopolies , Econometrica 51, 1469-1484.). Competition and monopoly in the old pr oduct market provide identical returns to innovation when (i) the mono polist is protected from new product entry, and (ii) innovation is non -drastic, in the sense that the monopolist supplies positive quantitie s of both old and new products. If the monopolist can be threatened wi th entry, monopoly provides strictly greater incentives, Welfare may b e greater under monopoly when innovation is valuable. Published by Els evier Science B.V.