CHAPTER 14 Models of Competitive Innovations The previous chapter presented the basic endogenous technological change models based on expanding input or product varieties The advantage of these models is their relative tractability While the expansion of the types of machines that can be used in production captures some of the flavor of process innovations, most of the process innovations we observe in practice either increase the quality of an existing product or reduce the costs of production For example, in the expanding machine variety model, when a new computer is invented, it is used alongside all of the previous vintages of the computer In fact, the increase in the varieties of computer types is important, since economic growth is driven precisely from the love-for-variety aspect of the Dixit-Stiglitz production function However, in practice, when a better computer comes to the market, it does not complement previous models but replaces them Therefore, in some fundamental sense, models of expanding machine variety not provide a good description of innovation dynamics in practice because they not capture the competitive aspect of innovations Our purpose in this chapter is to develop tractable models of economic growth with “competitive innovations” As Chapter 12 discussed, competitive innovations–involving quality improvements or cost reductions–introduce the replacement effect, which implies that entrants should be more active in the research process than incumbents Competitive innovations therefore raise a number of novel and important issues First, in contrast to the models of expanding varieties, there may be direct price competition between different producers with different vintages of quality or different costs of producing the same product This will affect both the description of the growth process and a number of its central implications For example, market structure and anti-trust policy can play potentially richer roles in models exhibiting this type of price competition Second, competition between incumbents and entrants leads to the business 609