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Underinvestment and market structure

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  • Nocke, Volker

Abstract

This paper analyses a dynamic game of investment in R&D or advertising, where current investments change future market conditions. It investigates whether underinvestment can be supported in equilibrium by the threat of escalation in investment outlays. When there are no spillovers, or there is full patent protection, underinvestment equilibria are shown to exist even though, by deviating, a firm can get a persistent strategic advantage. When there are strong spillovers and weak patent protection, underinvestment equilibria fail to exist. This implies that weaker patent protection can actually lead to more investment in equilibrium. Furthermore, potential entry is introduced into the model so as to address the issues of market structure. It is shown that underinvestment equilibria can be stable with respect to further entry, independently of market size and entry costs. Finally, the 'nonfragmentation' result of static stage games is proved to hold in this dynamic game.

Suggested Citation

  • Nocke, Volker, 1998. "Underinvestment and market structure," LSE Research Online Documents on Economics 6754, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:6754
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    File URL: http://eprints.lse.ac.uk/6754/
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    Cited by:

    1. Ulrich Doraszelski & Sarit Markovich, 2004. "Advertising Dynamics and Competitive Advantage," Computing in Economics and Finance 2004 61, Society for Computational Economics.

    More about this item

    Keywords

    Dynamic games; investment; collusion; industry structure;
    All these keywords.

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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