Costly innovators versus cheap imitators: a discrete choice model

Two alternative ways to an innovative product or process are R&D investment or imitation of others’ innovation. In this article we propose a discrete choice model with costly innovators and free imitators and study the endogenous dynamics of price and demand in a market with many firms producing a homogeneous good. The basic idea is that imitation works better the more innovators are around, with a trade off between the advantages of the two strategies. First we look at innovation as costs reduction in a perfectly competitive market. Here we also study the stabilizing or destabilizing effect of memory and asynchronous updating of strategies. Then we introduce endogenous technological progress and analyze the determinants of the speed of price reduction as well as the occurrence of an initial oscillatory phase that precedes convergence. An extension of the model introduces product differentiation addressing the effects of innovation on demand. While the basic version of the model have stable equilibrium or cyclical behaviour, there are conditions for chaotic behaviour of price and agents’ choices. This is the case of long memory and asynchronous updating of strategies, as well as with innovations affecting demand. These results indicate how the dynamical interplay of innovators and imitators can
contribute to markets variability.