The Impact of Cost-Reducing R&D Spillovers on the Ergodic Distribution of Market Structures

We present a dynamic duopoly model of R&D with spillovers where industry concentration is endogenous. In our model, firms compete repeatedly in both the product market via Cournot competition and in imperfectly appropriable process R&D. The analysis highlights the effects of spillovers through dynamic changes in industry concentration, which cannot be obtained in a static setting. To date the analysis of R&D spillovers between firms has been largely restricted to static two-stage models (R&D decisions followed by product market decisions). In contrast to the standard result in that literature, we present cases where greater spillovers lead to higher product market concentration. We find that the impact of imperfect appropriability of R&D depends crucially on the manner in which spillovers are obtained. If spillovers are costless (Spence, 1981), then they display non-monotonic effects on concentration and welfare and the direction of change depends on the initial(no spillovers) ergodic distribution of market shares. If spillovers require absorptive capacity (Cohen & Levinthal, 1989) spillovers generally have monotonic effects, but the direction of change still depends on the initial ergodic distribution. In addition, spillovers can increase or decrease welfare and the direction is again dependent on the initial distribution and how spillovers are obtained.