Competition and Product Innovation in Dynamic Oligopoly

We investigate the relationship between competition and innovation using a dynamic oligopoly model that endogenizes both the long-run innovation rate and market structure. Determinants of competition, such as product substitutability, entry costs, and innovation spillovers, affect firms' equilibrium strategies for entry, exit, and R&D. We find an inverted-U relationship between product substitutability and innovation: the returns to innovation initially rise for allfirms but eventually, as the market approaches a winner-take-all environment, laggards have few profit scraps to fight over and give up pursuit of the leader, knowing he will defend his lead. We also find competitive forces interact with each other: innovation exhibits a positive relationship with spillovers when product substitutability is high but is unaffected by the spillover when substitutability is low. Entry costs and innovation exhibit a U-shaped relationship that results from entry-deterring R&D by laggards.