The Incentive to Adopt Cost Reducing Innovation in the Presence of a Non-Linear Demand Curve

Abstract

The degree to which structure of an industry rewards introduction of a process improvement is one consideration which enters into a discussion of relative merits of monopolistic and competitive industries. There have been conflicting results concerning which industry provides greater incentive. The incentive to an inventor is additional profits, resulting from adoption of innovation. In competitive industry a patent or royalty system is established by government to insure that inventor is able to appropriate all profits from invention. However, in monopolistic industry it is assumed that monoplist is only one capable of innovation and subsequent adoption of innovation.' Kenneth Arrow demonstrated that the incentive to invent is less under monopolistic than under competitive conditions... [1, 619]. This occurs because profits are initially zero in competitive industry, while they are positive in monopolistic industry due to an exploitation of monopoly power. Subsequently, monopoly power is given to inventor in competitive industry because royalty system has been established by government. This implies that inventor in competitive industry is able to reap additional profits, since inventor would receive benefits from an exploitation of monoply power as well as from reduction in cost resulting from adoption of new innovation. In a subsequent article Harold Demsetz reversed this conclusion in that at least in linear model of two industries of equal output size, more monopolistic will give greatest encouragement to invention [4, 19]. The distinction between Arrow's and Demsetz's results is predicated on Demsetz's assertion that