Cost Signals under Uncertain R&D Outcomes

Chris Y. Tung and Chun-Chieh Wang

Australian Economic Papers, 2014, vol. 53, issue 3-4, 207-229

Abstract: type="main">

When it is difficult for firms to differentiate their products from those of their competitors, research and development (R&D) spending on process innovation to lower the cost of production is crucial for profitability. However, the information asymmetry in production costs that results from innovation reduces the efficiency of all firms in a market for a homogeneous good. We employ a signalling game to discuss the feasibility of utilising R&D spending and output levels as cost signals in an environment of quantity competition. The results show that a firm does not spend its money on R&D solely to signal the type of cost. Rather, R&D spending may be chosen as a cost signal over the output level only if expenditures on R&D can lead to a sufficiently high probability of reducing production costs.

Date: 2014
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