Entry Deterrence through Fixed Cost Reducing R&D

The paper explores the role of R&D investments reducing fixed production costs in entry deterrence. An incumbent monopolist and a potential entrant can perform R&D to reduce their fixed production costs, with bidirectional and asymmetric technological spillovers. It is shown that deterrence, which takes the form of underinvestment in R&D by the incumbent, is more likely when the spillover from the incumbent to the potential entrant is high, when the spillover from the potential entrant to the incumbent is low, and when the fixed cost is intermediate. The role of two policy instruments, R&D subsidies and intellectual property protection, is examined.