Dynamic Efficiency

Market structure and technological advance.

Pure competition-Although purely competitive firms may have an incentive to keep ahead of their competitors, the small size of the firms and the fact that there are no barriers to entry and therefore they can earn only a normal profit in the long run, leads to serious questions as to whether such producers can benefit from and finance substantial R&D programs.

Monopolistic competition-There is a strong profit incentive to engage in product development in this market structure. However, most firms remain small, which limits their ability to secure financing for R&D. Economic profits are usually temporary because there are few barriers to entry.

Oligopoly-The oligopolistic market structure is conducive to technical advance. Firms are large with ongoing economic profits, are protected by barriers to entry, and have large volume of sales. Although oligopolistic firms have the financial resources to engage in R&D, they are often complacent.

Pure monopoly-Pure monopolists have little incentive to engage in R&D. Since profits are protected by absolute barriers to entry, the only reason for R&D would be defensive, i.e., to reduce the risk of a new product or process that might destroy the monopoly.

Inverted-U Theory (p. 252-3; Figure 13-7)

• The inverted U suggests that both very low-concentration industries and very high-concentration industries expend a relatively small percentage of their sales revenue on R&D.
• The optimal market structure for technological advance seems to be an industry in which there is a mix of large oligopolistic firms (a 40 to 60 percent concentration ratio) with several highly innovative smaller firms.
• Competitive firms are small, which makes it difficult for them to finance the R&D, and there is easy entry by competitors. Where firms have a substantial amount of monopoly power, monopoly profits are large and innovation will likely not add much more to the firm's profits.
• The level of R&D spending within an industry seems to be determined more by the industry's scientific character and "technological opportunities" than from its market structure.