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Optimal R&D Subsidies with Heterogeneous Firms in a Dynamic Setting

Author

Listed:
  • Joshua Hall

    (University of Tampa)

  • Christopher Laincz

    (Department of Economics & International Business LeBow College of Business Drexel University)

Abstract

When firms engaged in R&D are observably heterogeneous (in size) and policymakers are able to condition policy on the observed heterogeneity, what is the optimal policy? This paper starts with a static two-stage duopoly model of R&D competition with uncertainty and finds it welfare enhancing to subsidize the larger firms, with no subsidies for (or taxes on) the smaller firm (extending existing results, Lahiri and Ono, 1999). This result follows because marginal cost reductions by the largest firm have larger net effects on consumer and producer surplus. The policymaker's goal is effectively to minimize the average cost of production. However, when we move to a dynamic setting, the optimal policy is less clear. When firms compete repeatedly, the degree of competition becomes an endogenous variable over the infinite horizon. The optimal policy depends on the nature of long-run competition. In some situations, the optimal policy remains the same, subsidize the larger firm. However, in other scenarios, the policymaker optimally chooses to subsidize the smaller firm more heavily to promote more intense competition which lowers the long-run deadweight loss and long run costs through increased R&D competition.

Suggested Citation

  • Joshua Hall & Christopher Laincz, 2012. "Optimal R&D Subsidies with Heterogeneous Firms in a Dynamic Setting," School of Economics Working Paper Series 2012-13, LeBow College of Business, Drexel University.
  • Handle: RePEc:ris:drxlwp:2012_013
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    References listed on IDEAS

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    Cited by:

    1. Gamal Atallah, 2019. "Subsidizing Innovation and Production," Revista Economía, Fondo Editorial - Pontificia Universidad Católica del Perú, vol. 42(84), pages 9-35.

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    More about this item

    Keywords

    R&D; subsidies; duopoly; dynamics; heterogeneous firms;
    All these keywords.

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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