Using several simple examples, this paper shows that the effects of increasing competition on cost-reducing investments can be positive, negative or non-monotone. Also, competition is more likely to increase the investments of leaders than of laggards. To explain these findings, I use a reduced-form model. I identify four different transmission channels by which competition affects investments. Competition typically (i) reduces markups, but (ii) increases the sensitivity of equilibrium demand to marginal costs — this already implies countervailing effects on investment incentives. These difficulties are compounded because competition has ambiguous effects on (iii) the level of equilibrium demand and (iv) the extent to which efficiency gains are passed through to consumers as lower prices. Because of these ambiguities, there is not much hope of establishing a robust relation between competition and investment.
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Paper provided by University of Zurich, Socioeconomic Institute in its series Working Papers with number
0716.
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