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OPTIMAL R&D SUBSIDIES WITH HETEROGENEOUS FIRMS IN A DYNAMIC SETTING

Published online by Cambridge University Press:  16 July 2019

Joshua D. Hall  and
Christopher A. Laincz
Joshua D. Hall*
Affiliation:
Florida Southern College
Christopher A. Laincz
Affiliation:
Drexel University
*
Address correspondence to: Joshua D. Hall, Florida Southern College, 111 Lake Hollingsworth Drive, Lakeland, FL 33801, USA. e-mail: jhall2@flsouthern.edu. Phone: 863-680-3010.
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Abstract

When observably heterogeneous firms engage in R&D and policy can be conditioned on the heterogeneity, what is the optimal policy? This paper starts with a static duopoly model of R&D competition with uncertainty and finds it welfare enhancing to subsidize the larger firms with no subsidies for the smaller firm, extending existing results. This result follows because the policymaker’s goal is to minimize the average cost of production. Our paper demonstrates that these results are not robust to a dynamic setting. The optimal policy depends on the equilibrium type of competition that emerges without intervention—an insight that cannot be found in a static setting. In a dynamic setting, the degree of competition becomes an endogenous variable. Interestingly, although the optimal policy in some cases provides a slightly larger subsidy for the larger firm, it is the smaller firm that benefits most in terms of firm value.

Keywords

R&D PolicyDynamic SettingIndustrial OrganizationDuopoly
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 7 , October 2020 , pp. 1815 - 1849
Copyright
© Cambridge University Press 2019

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Footnotes

The authors would like to thank Andrew Gellert, Adeliada Mehmetaj, and Lien Ta for their excellent research assistance.

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