Heidrun C. Hoppe and Ulrich Lehmann-Grube

This paper explores a dynamic model of product innovation, extending the work of Dutta, Lach, and Rustichini (1995). It is shown that if R&D costs for quality improvements are low, the dynamic competition is structured as a race for being the pioneer firm with payoff equalization in equilibrium, but switches to a waiting game with a second-mover advantage in equilibrium if R&D costs are high. Moreover, the second-mover advantage increases monotonically as R&D becomes more costly.