Pollution abatement with disruptive R&D investment

This paper examines a model of investment in abatement where polluting firms produce output while investing in R&D. This investment, however, increases production costs, thus disrupting first-period output. We identify three equilibrium profiles where firms choose to either: (1) invest in R&D alone (thus rationalizing a common modeling assumption in the literature); (2) produce output alone; or (3) engage in both activities. We evaluate how the emergence of each result is affected by the market structure in which firms compete and by the severity of spillover effects. We then measure welfare levels in each equilibrium profile. Overall, we show that firms endogenously choose to focus on R&D only when the market is concentrated and spillover effects are small. In other type of industries, our findings indicate that firms may focus on output production or engage in both activities under relatively large conditions.