Cost structures and innovation incentives

Abstract

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/technological retrogression (henceforth 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 retrogression. We bring forth the unconventional but interesting relationship between the intensity of competition and welfare – $\forall n>3$ 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.