DP4369 Innovation and Competitive Pressure

Author(s): Xavier Vives
Publication Date: April 2004
Keyword(s): corporate governance, cost reduction, entry, globalization, market concentration, market size, product introduction, R&D, substitutability
JEL(s): L13, O30
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4369

I analyse the effects of competition on R&D effort (in a non-tournament context) and obtain robust results that hold for a variety of market structures, including markets with and without barriers to entry and markets characterized by either price or quantity competition. The approach encompasses models of direct investment to reduce costs as well as models where cost reduction arises because the agency problem between managers and owners in an asymmetric information context (X-inefficiency) is better resolved. It is found that increasing the number of firms tends to reduce R&D effort, whereas increasing the degree of product substitutability, with or without free entry, increases R&D effort – provided that the total market for varieties does not shrink. Increasing the total market size increases both R&D effort and (weakly) the number of varieties.