Dropout Behavior in R&D Races with Learning

We examine a game-theoretic model of a two-firm R&D race in which expenditures on R&D and the concomitant increase in experience/learning enable the firms to increase their probability of discovering an invention. The learning process is stochastic. It generates a unique subgame-perfect equilibrium for identical firms with the characteristic that the leader never drops out, but the follower drops out if the leader gains a significant lead. The leader can find it optimal to drop out if the firms value the invention differently or have different R&D efficiencies. Thus, our analysis generates results between vigorous competition and natural monopoly.