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Monopoly and the incentive to innovate when adoption involves switchover disruptions

  • Thomas J. Holmes
  • David K. Levine
  • James A. Schmitz

When considering the incentive of a monopolist to adopt an innovation, the textbook model assumes that it can instantaneously and seamlessly introduce the new technology. In fact, firms often face major problems in integrating new technologies. In some cases, firms have to (temporarily) produce at levels substantially below capacity upon adoption. We call such phenomena switchover disruptions, and present extensive evidence on them. If firms face switchover disruptions, then they may temporarily lose some unit sales upon adoption. If the firm loses unit sales, then a cost of adoption is the foregone rents on the sales of those units. Hence, greater market power will mean higher prices on those lost units of output, and hence a reduced incentive to innovate. We introduce switchover disruptions into some standard models in the literature, show they can overturn some famous results, and then show they can help explain evidence that firms in more competitive environments are more likely to adopt technologies and increase productivity.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 402.

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Date of creation: 2008
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Handle: RePEc:fip:fedmsr:402
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