Imitative Competition and Product Innovation in a Duopoly Model

This paper investigates imitative competition in a two‐stage game of strategic product choice in a vertically differentiated market. The innovator chooses its product strategy anticipating the subsequent entry of a rival firm. The rival firm chooses the degree to which it is profitable to differentiate its product from the innovator. It has the second mover advantage that its costs are lower the more closely it copies the innovator’s product. But against this advantage is the drawback that the more similar the two products are, the more intense is the price competition between the two firms. The trade‐off between imitation and differentiation is affected by the degree of consumer heterogeneity in the market. Consumers differ by income. The relationship between the incentive to imitate and the distribution of income is important, particularly in evaluating the welfare effects of two different policy responses, patent policy and cooperative alliances.