A Duality Between Cost-Reducing R&D versus Quality-Improving R&D and Welfare Analysis in a Hotelling Model

Two versions of research and development (R&D) activities in a Hotelling model with endogenous spillover effect, one with cost-reducing R&D and the other with quality-improving R&D, are analyzed in this paper. The result points out that two such kinds of R&D activities will share identical strategic properties, and that we shall be able to derive the equilibrium strategies of a quality-improving R&D model from those of a cost-reducing R&D model, and vice versa. It is found that the special market demand in a Hotelling model in fact plays a crucial role as well. This paper also provides a welfare analysis, the results of which show that government intervention via taxing the locations and subsidizing R&D efforts can remedy the market failure resulting from excess differentiation on locations and under-investment on R&D expenditures in non-cooperative equilibrium. Copyright International Atlantic Economic Society 2013