Competition as a Discovery Procedure: Schumpeter Meets Hayek in a Model of Innovation

I incorporate an insight of Friedrich Hayek - that competition allows a thousand flowers to bloom, and discovers the best among them - into a model of Schumpeterian innovation. Firms face uncertainty about the optimal direction of innovation, so more innovations implies a higher expected value of the `best' innovation. The model accounts for two seemingly contradictory relationships reported in recent empirical studies - a positive relationship between competition and industry-level productivity growth, and an inverted-U relationship between competition and firm-level innovation. Notwithstanding the positive relationship between competition and growth, I find antitrust policy reduces industry-level growth.