R&D wars and the effects of innovation on the success and survivability of firms in oligopoly markets

Using a two-stage model describing the optimal R&D choice of firms operating in an oligopoly market for several substitute goods we predict a convex (U-shaped) relationship between competition and innovation; that is, innovation declines as a function of product market competitiveness up to a certain level, and rises thereafter, when competition becomes intense. In other words, firms in an oligopoly market may engage in an "R&D war" and spend excessively on R&D when product market competition is intense. We also show, among other results, that when product market competition is intense, a monopoly may exhibit higher expected welfare and, sometimes, a higher expected consumer surplus than a duopoly.