How does Market Competition Affect Innovation?

Market competition can provide an incentive for discovering new technology because a firm can earn higher profits by finding a way to produce products more cheaply or to create products with characteristics consumers want. 

An innovative firm knows that it will usually have a temporary edge over its competitors and thus an ability to earn above-normal profits before competitors can catch up.

In certain cases, however, competition can discourage new technology, especially when other firms can quickly copy a new idea. 

 If the research and development (R&D) effort fails—and every R&D project has some chance of failure—then the firm will suffer losses and could even be driven out of business. 

If the project succeeds, then the firm’s competitors may figure out ways of adapting and copying the underlying idea, but without having to pay the costs themselves. 

As a result, the innovative company will bear the much higher costs of the R&D and will enjoy at best only a small, temporary advantage over the competition.

Related Topics

• Market Competition and Innovation
• New Technology and Positive Externalities

• Externality
• Network Externality
• Pigovian Tax
• Coase Theorem
• Agglomeration Diseconomies

• Education - Private and Social Rate of Return
• Government Approaches to Encouraging Innovation
• Public Good
• Public, Private, Club, Common Goods
• Excludable and Rivalrous Goods
• What is the Free Rider Problem for Public Goods?
• Free Rider
• Social Loafing
• Role of Government in Paying for Public Goods
• What is the Tragedy of Commons for Common Resources?
• Income Inequality
• Poverty Line?
• Poverty Trap
• Public Safety Net
• Measuring Income Inequality
• Lorenz Curve
• Ladder of Opportunity
• Tradeoff between Incentives and Income Equality