Date Added: Feb 2011
This paper develops an R&D-based growth model that features both vertical and horizontal innovation to shed some light on the current debate on whether patent protection stimulates or stifles innovation. Specifically, the authors analyze the growth and welfare effects of patent protection in the form of profit division between sequential innovators along the quality ladder. They show that patent protection has asymmetric effects on vertical innovation (i.e., quality improvement) and horizontal innovation (i.e., variety expansion). Maximizing the incentives for vertical (horizontal) innovation requires a profit-division rule that assigns the entire flow profit to the entrant (incumbent) of a quality ladder.