Modelo De Weinschenk (Boon, 2009)

Preprints of the Max Planck Institute for Research on Collective Goods Bonn 2009/11

Persistence of Monopoly and Research Specialization

Philipp Weinschenk

MAX PLANCK SOCIETY

Preprints of the Max Planck Institute for Research on Collective Goods

Bonn 2009/11

Persistence of Monopoly and Research Specialization

Philipp Weinschenk

April 2009

Max Planck Institute forResearch on Collective Goods, Kurt-Schumacher-Str. 10, D-53113 Bonn http://www.coll.mpg.de

PERSISTENCE OF MONOPOLY AND RESEARCH SPECIALIZATION
Philipp Weinschenk∗
Bonn Graduate School of Economics and Max Planck Institute for Research on Collective Goods April 1, 2009
Abstract We examine the persistence of monopolies in markets with innovations when the outcome of research is uncertain. We showthat for low success probabilities of research, the incumbent can seldom preempt the potential entrant. Then the efficiency effect outweighs the replacement effect. It is vice versa for high probabilities. Moreover, the incumbent specializes in “safe” research and the potential entrant in “risky” research. We also show that the probability of entry has an inverted U-shape in the success probability.Since even at the peak entry is rather unlikely, the persistence of the monopoly is high.
Keywords: Persistence of Monopoly; Efficiency Effect; Replacement Effect; Stochastic Innovations. JEL Classification: L12, O31.

1. INTRODUCTION This paper takes a new look at monopoly persistence in markets with innovations. The extensive literature on the subject has discussed this issue in terms of theefficiency effect and the replacement effect. Since competition destroys profits, the efficiency effect predicts that the incumbent’s incentive to remain a monopolist through innovating is at least as great as the entrant’s incentive to become a duopolist. The replacement effect (Arrow, 1962) predicts the opposite: The entrant’s incentive to innovate is higher than the incumbent’s because only the incumbent takesinto account that innovating replaces its existing technology. According
Max Planck Institute for Research on Collective Goods, Kurt-Schumacher-Str. 10, 53113 Bonn, Germany, weinschenk@coll.mpg.de. I thank Philippe Aghion, Felix Bierbrauer, Stefanie Brilon, Andrew Daughety, Mathias Dewatripont, Christoph Engel, Paul Heidhues, Martin Hellwig, Fabian Herweg, Jos Jansen, Stephan Lauermann, DanielM¨ller, Tymofiy Mylovanov, Jennifer Reinganum, Nora Szech, Andrea Witu tke, as well as seminar participants at the Max Planck Institute for Research on Collective Goods, the 2007 Summer School on Contract Theory at Bronnbach, the University of Bonn, the 2008 ZEW Conference on the Economics of Innovation and Patenting at Mannheim, and the 2008 EEA Conference at Milan.
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WEINSCHENK: PERSISTENCE OFMONOPOLY

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to the classical work of Gilbert and Newbery (1982; henceforth GN) the efficiency effect determines the outcome, whereas in a seminal paper by Reinganum (1983; henceforth RE) it is the replacement effect.1 We build a unifying model in which both effects are present. We allow for uncertainty with respect to the outcomes of innovative activities and show that the success probability ofresearch determines the relative strength of both effects. We consider a monopolized market, where the first-moving incumbent may be able to discourage the potential entrant from investing in research by investing itself.2 The outcomes of research activities are uncertain. Therefore, preemption is less than perfect. For high success probabilities we obtain a result in the spirit of GN: preemption isalmost perfect so the efficiency effect is the driving force. Intuitively, since the success probability is high the potential entrant’s expected profit from research greatly depends on the incumbent’s research decision. Hence, it is very likely that the incumbent can and does preempt the potential entrant. For low success probabilities the same argument applies in reverse, i.e., the incumbent...