PART V RESEARCH & DEVELOPMENT

PART V RESEARCH & DEVELOPMENT

- Focus on industry changes due to new products or new production processes

- Central role of R&D

- To measure R&D intensity: R&D expenditure / Total sales

- Questions:

! Why does R&D intensity vary from one sector to another?

! Effect of the market structure?

! Are today’s R&D leaders likely to remain leaders in the future?

! What can public policy do to favor investments in R&D?

V.1 MARKET STRUCTURE AND INCENTIVES FOR R&D

- So far, from a policy perspective, the optimal market structure is the one that minimizes market power

- Accounting for innovation, what is the market structure that favors R&D?

- Schumpeter (1950): In favor of concentrated markets to favor R&D.

! Illustration: AT&T/Bell Labs, a monopoly until the 80s’, responsible for some important discoveries of the XXth century (transistor, laser)

- Paradox:

! Incentives for R&D are stronger in a competitive market

Illustration

- Consider an innovation that decreases variable production costs from c_H to c_L.

! Gains for a monopoly = q_M (c_H - c_L)

! Gains for a small price taker firm = q_C (c_H – c_L)

- Replacement effect

- Compatible with Schumpeter hypothesis:

! Ability to invest vs. incentives to invest

V.2 THE DYNAMICS OF R&D COMPETITION

The efficiency effect and the persistence of monopoly

- Consider one monopoly, one potential entrant and one lab who, which wants to sell an gradual innovation.

- What firm is willing to pay the most for the innovation?

- The monopoly is willing to pay ΠM – ΠD

- The potential entrant is willing to pay ΠD – 0 - Persistence of the monopoly since ΠM > 2 ΠD

- OK if the product is homogeneous and the marginal costs are constant - Gradual innovation, not drastic

The replacement effect and creative destruction

- Consider the same model as before, with the following variation - ρ is the probability to have an offer from any potential entrant - WTP of the monopoly: ΠM – {(1 – ρ⁾ ΠM + ρ ΠD} = ρ ⁽ΠM – ΠD) - WTP of a potential entrant: ΠD

- Persistence of the monopoly only if ρ ΠM > (1 + ρ⁾ ΠD

- If the uncertainty about the presence of a potential rival is high (ρ is low), the monopoly’s WTP is lower because it is less willing to replace its old benefits by new ones.

With a drastic innovation

- A drastic innovation makes the old product obsolete

- If the potential entrant obtains the innovation, it becomes the new monopoly - WTP of the monopoly: ΠM – {(1 – ρ⁾ ΠM + ρ 0 } = ρ ΠM

- WTP of a potential entrant: ΠM

- Potential entrants have stronger incentives to invest in drastic innovations

Learning by doing

- Persistence of dominant firms

V.3 PUBLIC POLICY

- Economic growth and welfare highly depend on R&D

- Public policy to ecourage R&D, among which:

! Patents

! R&D agreements

Patents

- Patents to reward succesfull R&D - Monopoly power, expost inefficiency

- Trade-off ex ante incentives with ex post inefficiency - The strength of a patent depends on its length

- What about compulsory lincencing?

Compulsory licencing of a patent

- Without licencing: monopoly equilibrium

€

Π^M = 1 b

a−c 2

⎛

⎝ ⎜ ⎞

⎠ ⎟

2

€

P^M = a+c 2

€

DWL^M = 1 2b

a −c 2

⎛

⎝ ⎜ ⎞

⎠ ⎟

2

- With compulsory licencing:

!

€

Maxq_A Π_A = (p − c)q_A +α^q_B ⇒ q_A = a− c −bq_B 2b

!

€

Maxq_B Π_B = (p − c −α)q_B ⇒ q_B = 1

2b

(

)

- Duopoly equilibrium, with

€

q_A = a−c+α 3b

€

q_B = a− c−2α 3b

€

Q = 2(a −c)−α 3b

€

P = a+ 2c+α 3

€

Π_A = 1 b

a− c+α 3

⎛

⎝ ⎜ ⎞

⎠ ⎟

2

+ (a −c −2α⁾α 3b

€

Π_B = 1 b

a −c− 2α 3

⎛

⎝ ⎜ ⎞

⎠ ⎟

2

R&D agreements

- Generally, competition authority disapprove agreements between firms

- With R&D, we have spillovers

• Innovation as a public good

• Free-riding, lower incentives for R&D

• Underinvestment in R&D

- R&D agreements decrease free-riding and the risks associated with R&D - They also decrease the incentives to invest in R&D