Innovation and Horizontal Differentiation in a Continuous-Time Hotelling Model

28 Pages Posted: 8 Jul 2008

See all articles by Borghan Narajabad

Borghan Narajabad

Board of Governors of the Federal Reserve System

Randal Watson

University of Texas at Austin - Department of Economics

Date Written: June 28, 2008

Abstract

We study the relationship between innovation and horizontal differentiation in a continuous-time dynamic duopoly. At any instant firms compete in prices in a Hotelling game. They may be differentiated both in terms of product quality (for which consumers have homogeneous tastes) and product location (for which tastes are heterogeneous). We consider in turn: (a) a game in which firms invest to improve quality (with fixed locations), and (b) a game in which they invest to relocate products (with an exogenous rate of quality improvement). Spillovers keep the interfirm quality differential from becoming too large. Symmetric Markov-perfect equilibria in the game with fixed locations show a relationship between taste heterogeneity and quality improvement that is U-shaped, in contrast with previous literature. In the game of endogenous product locations we show conditions for uniqueness of the symmetric MPE, and use this result to examine long-run impacts of changes in parameters, e.g., in the costs of product relocation.

Keywords: Innovation, horizontal differentiation, Markov-perfect equilibria

JEL Classification: L13, O31

Suggested Citation

Narajabad, Borghan and Watson, Randal, Innovation and Horizontal Differentiation in a Continuous-Time Hotelling Model (June 28, 2008). Available at SSRN: https://ssrn.com/abstract=1155856 or http://dx.doi.org/10.2139/ssrn.1155856

Borghan Narajabad

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Randal Watson (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

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