Presentation on theme: "Course outline I Homogeneous goods Introduction Game theory"— Presentation transcript:
1 Course outline I Homogeneous goods Introduction Game theory Price settingmonopolyoligopolyQuantity settingProcess innovationHomogeneous goods
2 Innovation competition Product versus process innovationDrastic versus non-drastic innovationPatent raceIncentives to innovateExecutive summary
3 Research and development Three levels of research:fundamental researchapplied research with project planningdevelopment of new products and their commercializationInnovation of product and processThree stagesinventionadoptiondiffusion
4 Five models Patent race with respect to process innovation Process innovation leads to reduction of average cost:Incentives to innovate forbenevolent dictatormonopolistperfect competitiontwo symmetric firmstwo asymmetric firms
5 Benevolent dictator v. monopolist xxMRincentive to innovate
6 Drastic v. non-drastic innovation ppInnovator enjoys blockadedmonopoly,drasticinnovationnon-drasticinnovationxx
7 Exercise (drastic or non-drastic innovation) Inverse-demand function p=a-XAll firms have identical unit costs , whereOnly one firm reduces its unit cost toInfer kind of innovation
8 Perfect competition Incentives to innovate for drastic innovation for non-drastic innovation(compare next slide and slide „ Benevolent dictator v. monopolist”)
10 Assumptions and notation for dyopolistic innovation competition Patent race with respect to process innovationR&D expenditure of firms 1 and 2:A measure of innovation difficulty :Innovation probability of firm i:Probability of no innovation:
11 Exercise (innovation probability) How does the innovation probability depend on F0 , F1 and F2.F0100F034F06F0½ F0F2F1Innovation probability of firm 1
12 Symmetric innovation competition F 1F 2P 1P 2Initially, none of the firms is in the market. The successful firm enters the market and receives
13 Equilibrium (symmetric case) Profit function of firm 1Reaction function of firm 1Nash equilibrium ,
15 Exercise (sequential symmetric case) Consider the symmetric case with F0=0. Calculate an equilibrium in the sequential game:
16 Asymmetric case: one incumbent, one potential competitor Monopolist (firm 1) withaverage cost , and potential competitor (firm 2)Process innovations leads to reduction of average cost:Profits, net of R&D expenditureNo firm innovatesEstablished firm innovatesEntrant innovates (price competition)P 1P 2F 1F 2p 1p 2
17 Profit functions (asymmetric case) Profit function of firm 1 (monopolist)Profit function of firm 2
18 Incentives to innovate No firminnovates.Monopolistinnovates.Entrantinnovates.
19 Replacement effect (Arrow) The Arrow terms are defined as the profit differences a firm enjoys by innovating rather than not innovating.If the incumbent innovates, he replaces himself. If the entrant innovates, he achieves positive profits as compared to zero profits:
20 p p x x drastic innovation nondrastic innovation Incentive to innovate from replacementeffectfor established firmfor potential competitor
21 Efficiency effect (Gilbert, Newbery) The Gilbert-Newbery terms are defined as the profit differences a firm enjoys if she herself rather than her competitor innovates.The established firm’s incentive to remain a monopolist is greater then the entrant’s incentive to become a duopolist:
22 Gilbert-Newbery effect: From previous slide follows:Drastic innovation firm 2blockade and ”=” in equation (1)Nondrastic innovation firm 2deterrence and ”<” in equation (1) equation on previous slide is true
23 Replacement versus efficiency effect Replacement effectentrant has a greater incentive to innovateEfficiency effectestablished firm has a greater incentive to innovate
24 Equilibrium (asymmetric case) Reaction function of firm 1Reaction function of firm 2Nash equilibrium: “forget it“
25 Identifying the replacement effect The greater the monopoly’s profit without innovation, the less are the monopolist’s incentives to innovate:
26 Special case: efficiency effect only Hypothesis: F0 = i.e., it is certain that one of the two firms innovatesReaction function of firm 1Reaction function of firm 2Nash equilibrium:
27 Executive summary IThe higher the attainable monopoly profit, the higher the expenditures for R&D in the patent-race Nash equilibrium.The less likely successful innovation, the less all firms’ expenditures for R&D.R&D expenditures might be strategic complements or strategic substitutes.Sometimes, it may pay for the monopolist to file a patent but not to actually use it himself (sleeping patent).
28 Executive summary IIIncentives to innovate for the asymmetric duopoly:If the incumbent innovates, he replaces himself. If the entrant innovates, he achieves positive profits as compared to zero profits. replacement effectThe established firm’s incentive to remain a monopolist rather than becoming a duopolist is greater then the entrant’s incentive to become a duopolist. efficiency effect
29 Innovation competition with spill-over effect Basic ideaSimultaneous quantity competition (2nd stage)Simultaneous R&D competition (1st stage)Simultaneous R&D cooperation (1st stage)Comparison of R&D competition and R&D cooperationExecutive summary
30 Basic ideaIt is often not possible to internalise the benefits of R&D activities perfectly:employee turnoveranalysis of patentsR&D cooperation can be observed in some industries (e.g. PSA has different cooperation projects). On the product market, the firms may still compete.
31 The model Before the innovation The innovation reduces costs by measures the spill-over effect.Fi...R&D activity; C(Fi)...costs of R&D activityStructuretoF1F2x 1x 2
34 How Cournot outputs depend on „real“ R&D activityR&D activity
35 Exercise (R&D competition on 1st stage) Assume Find the symmetric equilibrium in the R&D game.
36 Analyzing direct and indirect effects (R&D competition) I Influence of F1 on firm 1’s profitdirecteffect=0>0<0=0strategiceffect
37 Analyzing direct and indirect effects (R&D competition) II Influence of F1 on firm 2’s profitdirecteffect=0?strategic effect=0>0<0
38 Exercise (R&D cooperation on 1st stage) We assume that firms cooperate on the first stage and compete on the second. Therefore:Firms want to maximize the joint reduced pro-fit functionWhile assuming the same quadratic cost func-tion as before, calculate the cartel solution.
39 Profit comparison of R&D competition and R&D cooperation
40 Analytical comparison of competition v. cooperation Does R&D competition yield higher R&D activities than cooperation?In our concrete model, we find
41 Graphical comparison of competition v. cooperation
42 Interpreting the comparison by way of external effects The influence of firm 1 on firm 2’s profit is an external effect; see slide „Analyzing direct and indirect effects (R&D competition) II“We foundBingo!
43 Executive summary: If spillover effects are sufficiently important, Firms want to underinvest in R&D for strategic reasons;Firms want to cooperate in order to prevent suboptimal R&D activities;Governments may allow R&D cooperation in order to enhance R&D activities.