This paper sets up a vertically related market model in which imitation and innovation are endogenously determined to study the impact of intellectual property rights (IPR) protection on less‐developed countries. It shows how a less‐developed country switches from imitation to innovation as it develops. It is also found that the relationship between IPR protection and economic development is U‐shaped. The IPR protection tends to go down and then go up as income rises. This finding also conforms with that in the empirical literature on IPR protection.