A strategic analysis of product and process innovation with spillovers
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The objective of this paper is to offer a conceptual framework for understanding the role played by spillovers in determining the optimal product and process innovation in a duopoly with a leader-follower configuration. A central concern is to address the question of whether higher spillovers favor more process or product innovations. We develop a two-stage non-cooperative R&D game of process and product innovation in a duopoly model which is distinct from Yin and Zuscovitch (1998) in the following way. Unlike the latter, we allow for process spillovers from which only the follower benefits in the model so that the follower's marginal cost of production is reduced not only by its own process innovation but also by a fraction of the leader's process investment. At the first stage of the game, the duopolists (the leader and the follower) will engage in product and process R&D. While product R&D is stochastic (in the sense that it realizes with a probability) and leads to the instantaneous discovery of a new product which leads to an outward shift of the firm's demand schedule, process R&D reduces the marginal cost of production with certainty. The two firms compete in the product market in the second stage. As in Yin and Zuscovitch (1998), results are derived by assuming that in the first stage the firm chooses product innovation taking process innovation as given and vice versa and finally the impact of spillovers on product and process strategies is found.
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