Product innovation and contestability

Summary This article deals with the introduction of product innovation in a contestable market model. Investment contestability describes a benchmark case of competition by introducing sunk entry-deterring investment in a free entry framework. Aside from careful price setting, suppliers adopt investment in product quality in order to deter entry. Zero-profit pricing and increased quality point to a partial second-best outcome of market behaviour.The author is very grateful for the support of Professor W.J. Baumol, The C.V. Starr Center for Research in Applied Economics at New York University, The Dutch Organisation of Scientific Research and an anonymous referee. Of course, the usual disclaimer applies.