Quadratic Costs, Innovation and Welfare: The Role of Technology

In a Cournot oligopoly set up with constant marginal cost and linear demand, innovation is rewarding. In this paper we work with a Cournot oligopoly framework with increasing marginal cost and linear demand and show that innovation may not be rewarding. We endogenize the success probability of R&D and its response to the intensity of competition and specifically show that if the technology is already advanced and competition intensifies then firms wouldn’t innovate. The dynamic interaction we attempt to capture and explain is the one of technology with the possibility of innovation via the intensity of competition. We finally conclude that the intensity of competition and welfare may not have the usual (direct) relationship and suggest ‘monitored competition’, wherein initially (at initial stages of innovation) competition is encouraged and then (at later stages of innovation) curtailed, to encourage innovation and thus welfare, as a suitable policy measure. Thus, entry should be restricted in order to foster innovation while innovation itself encourages entry.