Subsidizing Technological Innovations in the Presence of R&D Spillovers

Carsten Helm 1  and Anja Schöttner 2
  • 1 Technical University Darmstadt, Karolinenpl. 5,, Darmstadt, Germany
  • 2 University of Bonn,, Bonn, Germany

Abstract

We analyze a situation where a principal wants to induce two firms to produce an output, for example electricity from renewable energy sources. Firms can undertake non-contractible investments to reduce production cost of the output. Part of these investments spills over and also reduces production cost of the other firm. Comparing a general price subsidy and an innovation tournament, we find that the principal’s expected cost of implementing a given expected output is always higher under the tournament, even though this scheme may lead to more innovation.

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