R&D Incentives

In this chapter, we study firms’ incentives to invest in research and development (R&D) with the goal of lowering their production costs in subsequent periods. Exercise 6.1 starts analyzing these incentives in a stylized setting, a monopoly where a single firm operates in all periods. In this context, the monopolist anticipates that any R&D investment today will lower its production costs in the next period, when it still maintains a monopolistic position. In other words, the monopolist does not have incentives to invest in R&D to become more competitive in the future, relative to its rivals. In oligopoly models, however, every firm considers this incentive to improve its relative cost advantage. Exercises 6.2 and 6.3 examine this incentive, first in an oligopoly where firms compete in quantities (Exercise 6.2) and then in one where firms compete in prices (Exercise 6.3). In both exercises, we evaluate whether firms may have more or less incentives to invest in R&D than what they would under monopoly, which helps us identify whether the presence of more than one firm provides firm with an additional incentive to invest, relative to monopoly, or with less incentives. Exercise 6.4 then evaluates the welfare that arises in equilibrium, comparing whether that under monopoly is larger than under oligopoly, and Exercise 6.5 examines if R&D investments increase in oligopolistic markets that became more competitive (with more firms).