Research and development with publicly observable outcomes
Abstract This paper studies the simultaneous evolution of costs and research incentives in a model in which two firms research each period by purchasing a draw from a stationary distribution of possible production costs. Research decisions each period are based on the results of previous research which are common knowledge. When research stops a Bertrand pricing game occurs. We give conditions under which the perfect equilibrium of this game involves a race by both firms to reach some endogenously determined critical cost level. The first firm to reach this critical level wins the race, capturing the entire market, and continues to research until a second critical cost level is reached.