Market Structure and Technological Progress, a Differential Games Approach

This paper investigates dynamic process innovation in a product differentiated market where firms can reinvest present profits to reduce future costs. The focus is set on the market performance when the number of competing firms is determined by a social planner. The main contribution consists in developing a differential game to corroborate the central role of imperfect competition on optimal investment, which has been highlighted by the industrial organization literature. It is found that increasing the number of firms reduces process innovation, whereas raising the degree of competition between products increases it. The dynamic approach allows for a clear distinction between the positive effect on static welfare of increasing the number of firms and the dynamic efficiency loss due to reduced process innovation. It further characterizes the optimal market structure