Thesis advisor: Hideo Konishi / This paper will review prior research to support the notion that innovation does in fact lead to a competitive advantage for business, and that this competitive advantage is translated into increased profitability and productivity. Though the body of work reviewed here will by no means unequivocally prove that this relationship always holds true in real-world markets, it will provide a convincing argument that fostering innovation will likely have positive economic affects. Building off this assumption, this paper will then focus specifically on examining the relationship between environmental regulation and innovation in more detail. This paper looks to answer the question: Under what conditions will environmental regulation cause firms to begin choosing to innovate technologically rather than simply to meet regulation with compliance? Using a simple model of price competition between two firms it will be shown that environmental regulation can effectively induce innovation through spending on R&D projects to develop more efficient technology. / Thesis (BS) — Boston College, 2010. / Submitted to: Boston College. College of Arts and Sciences. / Discipline: Economics Honors Program. / Discipline: Economics.