Evaluating Welfare Losses Under R&D Rivalry and Product Differentiation

We evaluate the social welfare loss (WL) that arises in an oligopolistic industry under technological competition and product differentiation. The main novelty of our approach concerns the decomposition of the WL into `dynamic' losses (from too little cost reduction and an inappropriate number of research laboratories) and `static' losses (from suboptimal output levels and from `rent-seeking' behaviour). This allows us to explore the possibility of trade-offs between static and dynamic losses in the effect of competition policy (driving price towards marginal cost) and industrial policy (lengthening patent life). It also allows for an evaluation of the relative significance of these losses. We find that generally there is no trade-off with respect to industrial policy, but a trade-off emerges with respect to competition policy. The dominant components of WL are the dynamic loss from too little cost reduction and, especially, the `rent-seeking' losses. We also find that WL is increasing as regulation pushes price towards marginal cost and is decreasing as patent life increases.