We present a two-period dynamic model of standard setting under asymmetric information to model the attempts by the Califormia Air Resources Board (CARB) in getting car manufacturers to comply with its phase-in of stringent emissions standards. After CARB chooses an initial emissions standard that firms are required to comply with, automakers respond by choosing R&D investment and production levels which provide CARB an imperfect signal whether they are more or less capable of complying with the standard. CARB resets the environmental standard and the firms once again choose research and production levels. Firms are Cournot duopolists in the product market and can choose to do research noncooperatively or cooperatively in the presence of spillovers. We show that firms will behave strategically and underinvest in research both under competitive and cooperative R&D, though the level of underinvestment — the ratchet effect — is greater under cooperative R&D when spillovers are large. We uncover a fundamental conflict between the incentives of firms to do cooperative research and social welfare: that firms will want to engage in cooperative (resp. noncooperative) R&D only when spillovers are low (resp. high) while social welfare is greater under noncooperative (resp. cooperative) research.
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Paper provided by Department of Economics at the School of Economics and Management (ISEG), Technical University of Lisbon. in its series Working Papers with number
2004/16.
Length: Date of creation: 2004 Date of revision: Handle: RePEc:ise:isegwp:wp162004
Contact details of provider: Postal: Department of Economics, School of Economics and Management (ISEG), Technical University of Lisbon, Rua do Quelhas 6, 1200-781 LISBON, PORTUGAL Web page: http://www.iseg.utl.pt/departamentos/economia/
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