This paper aims to discuss whether product research and development (R&D) in developed economies tends to be too high compared with the socially desired level.
In this context, a model of vertical and horizontal product differentiation within the Dixit‐Stiglitz framework of monopolistic competition is set up. Firms compete in horizontal attributes of their products, and also in quality that can be controlled by R&D investments.
The paper reveals that in monopolistic‐competitive industries, R&D intensity is positively correlated with market concentration. Furthermore, welfare and policy analysis demonstrate an overinvestment in R&D with the result that vertical differentiation is too high and horizontal differentiation is too low. The only effective policy instrument in order to contain welfare losses is a price control of R&D services.
Considering the extent of product R&D as well as the political efforts to promote public and private research, this paper scrutinizes its benefit incorporating income and employment effects. Thus, it goes beyond partial‐analytical models of the existing industrial organization literature and provides a larger base of political analysis.
