The Relationship between Market Structure and Innovation in Industry Equilibrium: A Case Study of the Global Automobile Industry
40 Pages Posted: 22 Jul 2013 Last revised: 13 Aug 2014
Date Written: January 9, 2014
We specify and estimate a dynamic game to study the equilibrium relationship between market structure and innovation in the automobile industry. The quality of each firm's product for the average consumer, the key state variable, is modeled as stochastically increasing in innovation, the dynamic control, which is proxied by patent applications. Equilibrium innovation is a function of market structure, the vector of quality levels of all active firms, and the cost of R&D. Our main findings are as follows: (i) optimal innovation has an inverted-U shape in own-quality; (ii) holding own quality constant, innovation is declining in average rival quality, but increasing in quality dispersion; (iii) following entry, each incumbent's innovation declines, but aggregate innovation increases in most market structures. These findings are broadly consistent with the Schumpeterian hypothesis that market power leads to more innovation.
Keywords: Competition, Innovation, Dynamic Games, Schumpeter
JEL Classification: C73, L13, L62, O31
Suggested Citation: Suggested Citation