Better Product at Same Cost: Leader Innovation vs. Generic Product Improvement

We develop a parametric model in which a high-quality dominant firm faces a low-quality competitive fringe. We show that in this model, an increase in the dominant firm's product quality increases total welfare and consumer surplus. An increase in fringe firm quality has an ambiguous effect on total welfare, but always increases consumer surplus. Moreover, an increase in fringe quality always leads to a bigger increase in consumer surplus than does an increase in dominant firm quality, but the analogous comparison for total welfare is ambiguous. Finally, we show that an increase in dominant firm quality always increases total welfare by more than it increases consumer surplus, whereas for an increase in fringe firm quality, the opposite is true. The first of these findings relies on our parametric assumptions, but the others appear not to. We discuss the relevance of these results to public policy.