Simulating demand-side effects on innovation

We present an agent-based simulation model of the influence of heterogeneous demand on the innovative behaviour of firms. In our model, firms try to meet the demand of consumers with heterogeneous preferences for product attributes. Introducing heterogeneity into the model leads to a dynamic segmentation of markets and creates permanent and endogenous incentives for innovation and knowledge creation. The first striking result is that heterogeneity itself creates an out-of-equilibrium dynamic where no steady state is achieved: already a small deviation from perfect homogeneous demand creates a segmentation of markets with varying niches, which opens up the market for a large number of firms. Second, different degrees of consumer heterogeneity can create log-normal as well as normal distributions of firm sizes. Finally, simulation experiments indicate the impact of different policy strategies designed to foster innovation. In a situation where existing products do not meet consumer demand supply side, subsidies are only suitable under certain circumstances and may eventually cause major drawbacks.