Private Investment in Product and Process Innovation : Results from a Dynamic Model of R&D Allocation

This paper investigates the R&D allocation and output decisions of a profit-maximising monopolist developing a science-based family of products or processes. A comparison of the numerical solution for a model with incremental product innovation, and that with incremental process innovation, reveals that the central difference between the two is reflected in the optimised production plan. In either case, the optimal research plan is characterised by an initially high but declining rate of investment in exploratory research, and an inverted U-shaped path for applications-oriented R&D. The complementarity between research activities can generate dynamic increasing returns, with an S-shaped evolution in product quality or process efficiency. The results are consistent with empirical regularities identified in the innovation management literature and have a technological lifecycle interpretation. The long gestation periods and cumulative effects of knowledge investments have significant policy implications. Policies disturbing ongoing investment projects can cause abrupt short-run effects on R&D spending and output, influencing long run technological development differently to policies implemented ahead of projects' start