Cost Structures and Innovation Incentives

In a Cournot oligopoly set up with constant marginal cost and linear demand, innovation is rewarding, i.e., profit enhancing. We show that the same may not be true when marginal costs are increasing. In contrast to the standard results, we show the possibilities of conditional innovation/retrogression by firms: when the number firms n=1 or 2 innovation is undertaken by firms unconditionally and with certainty while for n>3 there exists an innovation–neutral technology line dividing the regions of innovation and technological retrogression (henceforth retrogression). We bring forth the unconventional but interesting relationship between the intensity of competition and welfare – ∀n>3 competition decreases welfare and thus leads to Pareto deterioration while the lack thereof enhances welfare and results in Pareto improvement. We suggest ‘monitored competition’ as in restricted entry to encourage innovation, as a potential policy instrument.

Views expressed in this article are solely those of the author and do not reflect the opinion or stand of the University.