Collusion and dynamic (under-) investment in quality

Abstract

In a dynamic game of investment in product quality, I investigate whether collusive underinvestment equilibria can be supported by the threat of escalation in investment outlays. When there are no spillovers, underinvestment equilibria exist even though, by deviating, a firm can gain a persistent strategic advantage. When there are strong spillovers, underinvestment equilibria fail to exist. A weakening of patent protection can thus lead to more investment in equilibrium. A "nonfragmentation" result is shown to hold: in all free-entry equilibria, industry concentration is bounded away from zero, no matter how large the market, and despite the existence of underinvestment equilibria. Copyright © 2007, RAND.