Does AMD spur Intel to innovate more?

We propose and estimate a model of dynamic oligopoly with durable goods and endogenous innovation to better understand the relationship between market structure and the evolution of quality. Firms make dynamic pricing and investment decisions while taking into account the dynamic behavior of consumers who anticipate the product improvements and declining prices. The distribution of currently owned products is a state variable that affects current demand and evolves endogenously as consumers make replacement purchases. Our work extends the dynamic oligopoly framework of Ericson and Pakes (1995) to incorporate durable goods and to yield an endogenous long-run rate of innovation. We estimate the model for the PC microprocessor industry and perform counterfactual simulations to measure the benefits of competition. Consumer surplus is 4.2 percent higher ($12 billion per year) with AMD than if Intel were a monopolist. Innovation, however, would be 4.2 percent higher without AMD present. Counterfactuals reveal that consumer surplus can actually increase as the market moves toward monopoly, which suggests policymakers should consider the dynamic trade-off of lower current consumer surplus from higher prices for higher future surplus from more innovation. Comparative statics reveal the effect on equilibrium outcomes of consumer preferences, depreciation, market growth, product substitutability, and innovation spillovers. For example, competition increases innovation if consumers highly value quality and have low price sensitivity or if the market growth rate is high. We also show that under either market structure, consumers of durable goods are the primary beneficiaries of innovation opportunities.