Working Paper: CEPR ID: DP1321
Authors: Stephanie Rosenkranz
Abstract: This paper investigates the strategic decisions of two identical duopolists, who choose production technology as well as product differentiation through their R&D investment. The product market is characterized by heterogeneous Cournot competition. Firms have an incentive to invest in both process innovation and product innovation. The optimal division between these two kinds of R&D activities changes with market size. The higher consumers' willingness to pay, the more firms' investment is driven to product differentiation. If firms coordinate their R&D activities and share R&D costs, but remain rivals in the product market, they will reduce costs and differentiate their products more than under competition. The optimal proportion of R&D investment is driven more to product innovation than under R&D competition. It can be shown that welfare is increased if firms coordinate their research activities and share R&D costs. When firms cooperate, but do not share their R&D costs, welfare is only enhanced if product innovations are not too expensive.
Keywords: product innovation; process innovation; R&D cooperation; market size
JEL Codes: C72; L1; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Consumers' willingness to pay (D11) | Firms' R&D investment (D25) |
| Firms' R&D cooperation (O36) | Greater efficiencies and product differentiation (L15) |
| Firms' R&D cooperation (O36) | Improved market outcomes (G19) |
| Nature of strategic interactions (forming R&D cartels) (L13) | Overall investment in product innovation (O36) |
| Nature of strategic interactions (forming R&D cartels) (L13) | Investments in process innovation (O31) |