An explanation for the inverted-U relationship between competition and innovation

Ferdinand Rauch

Vienna Economics Papers from University of Vienna, Department of Economics

Abstract: The Dixit-Stiglitz model is extended by the possibility for firms to undertake process innovation. The model can provide a new explanation to describe the relationship that research activity of firms is positively correlated with product market competition at low levels of competition, and negatively at high levels that has been found in the data. The initial positive relationship is caused by an increased business stealing opportunity with more competition, while the negative effect comes from the reduction of the markup due to higher competition (measured as elasticity of substitution). Also the ambiguous relationship of market entry barriers with respect to research activity is discussed using a less general form of the model. This framework may also be used to explain the inverted-U relationship found between competition and advertising expenditures.

JEL-codes: L10 O3 (search for similar items in EconPapers)
Date: 2008-12
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