Competition, Innovation and the Effect of Knowledge Accumulation

The question this paper addresses is how the market structure evolves due to innovative activities when firms' level of technological competence is valuable for more than one project. The focus of the work is the analysis of the effect of learning- by-doing and organizational forgetting in R&D on firms' incentives to innovate. I develop a dynamic step by step innovation model with history dependency. Firms can accumulate knowledge by investing in R&D. As a benchmark I show that without knowledge accumulation the leader's R&D effort increases with the gap as she is trying to avoid competition in the future. When firms gain experience by performing R&D the resulting effect of knowledge induces technological leaders to rest on their laurels which allows followers to catch up. Contrary to the benchmark case, the leader's innovation effort declines with the lead. This causes an equilibrium where the incentives to innovate are highest when competition is most intense.