Beyond the Arrow effect: income distribution and multi-quality firms in a Schumpeterian framework

This paper introduces multi-quality firms within a Schumpeterian framework. Featuring non-homothetic preferences and income disparities in an otherwise standard quality-ladder model, I indeed show that the resulting differences in the willingness to pay for quality among consumers generate both positive investments in R&D by industry leaders and positive market shares for more than one quality, hence allowing for the emergence of multi-product firms within a vertical innovation framework. This positive investment in R&D by incumbents is obtained with complete equal treatment in the R&D field between the incumbent patentholder and the challengers: in our framework, the incentive for a leader to invest in R&D stems from the possibility for an incumbent having innovated twice in a row to efficiently discriminate between rich and poor consumers displaying differences in their willingness to pay for quality. I hence exemplify a so far overlooked demand-driven rationale for innovation by incumbents. I am then also able to analyze the impact of inequality both on long-term growth and on the allocation of R&D activities between challengers and incumbents. I find that redistributive policies generally lead to an increase in the long-run growth rate, and to variations in the share of the overall R&D expenditures being undertaken by incumbents.