Monopoly, Competition and the Incentive to Invent: A Comment

Abstract

IN a paper published in 1962 Professor Arrow, using a simple formal analytical model, concluding that inventor's incentive under competition ... will ... always exceed monopolist's incentive.' In this Journal Professor Demsetz, modifying model in one important feature, reached opposite conclusion that at least in linear model of two industries of equal output size, more monopolistic will give greatest encouragement to invention, that is, the development of a monopoly invention . . . will receive greater rewards from a buying industry that is a monopoly.2 The purpose of present Comment is, first, to consider some of more institutional implications neglected in formal analysis, and, then, within framework of formal analysis explored by Arrow and Demsetz, briefly to present a case which can serve as a counter-example both to Arrow's and also to Demsetz's proposition. Demsetz compares a situation in which inventor produces a costreducing invention for a competitive industry with a comparable situation in which invention is used by a monopolist. After allowing specifically for output-restricting effect of monopoly, he shows that incentive to invent is greater in monopoly situation. To achieve this result, it is implied that monopolist pays for invention in form of a lump-sum payment (or series of lump-sum payments) regardless of his output, so that monopolist's marginal cost curve is not affected. Thus analysis refers to a situation of bilateral monopoly with a lump-sum payment. Bilateral monopoly introduces element of indeterminacy and bargaining into pricing process; and this affects degree of risk confronting inventor. That his risk may be increased (as compared with competitive situation) is clear when one considers case in which bargain-