Cost asymmetry and the R&D investment-decision game

This paper studies the R&D investment-decision game in a Cournot duopoly with ex ante asymmetric production costs. Firms first decide whether to participate in process R&D and, conditional on participation, subsequently choose their costreducing R&D efforts. Despite cost heterogeneity, investing is a strictly dominant strategy for both firms, so bilateral R&D is the unique participation equilibrium. Cost asymmetry nevertheless changes the nature of this outcome. When firms are sufficiently similar, bilateral R&D may constitute a prisoner’s dilemma; as the initial cost gap widens, the dilemma breaks down asymmetrically, with the initially efficient firm preferring bilateral investment while the inefficient firm continues to prefer mutual non-investment. Cost asymmetry also reallocates R&D effort toward the initially efficient firm. The welfare analysis reveals a further wedge between private and social incentives: although bilateral R&D maximizes aggregate R&D and consumer surplus, social surplus may be higher when innovation is concentrated in the initially efficient firm. Extending the model to technological spillovers leaves bilateral participation as the unique equilibrium but changes the private desirability of joint R&D.