Innovation and the Emergence of Market Dominance

Abstract

This paper analyzes a model of oligopolistic competition with ongoing investment. It incorporates the following models as special cases: incremental investment, patent races, learning-by-doing, and network externalities. We investigate circumstances under which a firm with low costs or high quality will extend its initial lead through further cost-reducing or quality-improving investments. In many commonly-studied oligopoly games, such investments are strategic substitutes. We derive a new comparative statics result that applies to games with strategic substitutes, and we use the result to derive conditions under which leading firms invest more than lagging firms. We show that the conditions are satisfied in a variety of commonly-studied oligopoly models. We also highlight plausible countervailing effects from two distinct sources. First, leading firms may find it more costly than others to achieve the same increment to their state. This force is particularly salient in many models of patent races, where firms make research investments in an attempt to find a new technology that delivers a given level of cost or quality. Second, countervailing effects may arise in dynamic games with more than two firms, when firms are sufficiently patient.

Key words: oligopoly games, strategic substitutes, innovation, investment, increasing dominance, market concentration

JEL Classification: L11, L13, L41, O30