One of the most important factors behind intertemporal variations in market structure, as well as prices, output and profitability of firms in an industry, is productivity and technology improvements occurring at firm-level. Activities such as research and development (R&D) and innovation which lead to the emergence and adoption of new technologies are crucial factors behind such changes. These activities are potentially beneficial to all firms and even if direct "free-riding" is prevented by patents, there are widespread indirect spill-over effects.
There is, however, another class of activities which includes firm-specific learning, organizational innovation, and other (firm-specific) efficiency enhancing activities which also play a significant role in productivity improvement and cost reduction by firms. Their common feature is firm-specificity they are determined almost entirely through internal investment and accumulation of experience within the firm with little, if any, potential benefit to other firms.
This paper focuses on the latter class of activities and analyzes the incentives for cost reduction offered by a competitive market as well as their consequences on the dynamics of industry structure and market variables. In particular, we characterize the dynamic equilibrium path of a competitive industry with a continuum of price-taking firms, free entry and exit, where individual firms undertake investment over time in order to reduce their future production cost.
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Reducing Investment, Competition and Industry Dynamics
