Q1: Does regulation decentivize innovation?
Q2: Is there more incentive to research new cost-cutting technologies in monopolistic or perfectly competitive markets?
Determining a monopoly’s behavior with respect to innovation is often very difficult
- Do they have cost-cutting incentives?
- Will those cost-cutting incentives lead to entry in the market?
- Is it better to cut costs using a patented technology or license off the technology and collect royalties?
Analyzing which market structures give rise to innovation is extremely difficult
- Many opposing theories exist among economists (despite ample research on this topic)
- Measuring innovation is difficult
We can summarize (and grossly simplify) two divergent views on the topic:
- Traditional View
- Predicts that competition compels firms to make the best use of all available means to increase profits (i.e. research new technologies)
Arrow (1962, 620). Put differently, the secure monopolist’s incentive to achieve a process innovation is less than that of a competitive firm because the monopolist with lower costs will merely replace itself, while the competitive firm will (by assumption) take over the market, in which it previously earned no economic profits. Tirole (1997, 392), dubbed this the “replacement effect.”
- Schumpeter’s Hypothesis
- Counters the traditional view by positing that the lure of excess profits serves as a powerful incentive for pursuing risky and uncertain innovations.
- Some degree of market power may serve as a precondition for this theory. It’s implicitly assumed that the risk-taking firm finances these risky ventures with previously earned excess profits.