Quality Improvement and Process Innovation in Monopoly: A Dynamic Analysis

We investigate the R&D portfolio of a monopolist investing in cost-reducing and quality enhancing R&D. Incentives along the two directions are inversely related to the size of market demand, and independent of each other. The stability analysis shows the existence of a unique stable steady state equilibrium, which is a saddle point. Finally, we show that the monopolist undersupplies product quality as compared to the social optimum, while its investment in the abatement of marginal cost is socially efficient.