Duopoly R&D competition with flexible spillovers

Abstract

A duopoly model of R&D competition is presented to investigate whether an equilibrium R&D level with flexible spillovers is insufficient (or excessive) from the viewpoint of social welfare. The model focus on flexible spillovers including much portion of externality occuring in R&D activity. Flexible spillovers refer to the spillovers that vary with industry equilibrium level of R&D. Both the technological leakage effect and the competition effect are included in flexible spillovers. In order to reflect the synchronous nature of R&D and production competition, the game is divided into two stages - R&D stage and production stage. Equilibrium output produced in production stage is determined noncooperatively. Innovating firms have incentives to cooperate in R&D in the presence of large spillovers. For any symmetric R&D profile, socially desirable equilibrium output is larger than equilibrium output produced in duopoly. In the presence of flexible spillovers it is observed that cooperative equilibrium R&D investment is socially insufficient and that noncooperative is excessive in terms of welfare criterion.