Impact of R&D Cartelization with Endogenous Product Differentiation

We analyze the multistage model of a duopoly in which firms decide on the level of product differentiation, R&D investment and production. The decision of differentiation is strongly related to the cost-reducing technology spillover. We find that there is a positive relationship between the level of substitution and R&D investment, which transfers into higher production and lower market price. The critical aspect of the paper is the welfare analysis of the cartelization in the market. We show that cooperation in R&D investment coordinates high investment with closer substitution, and it increases both firms profits and consumer welfare. Moreover, from the consumers' perspective, the total monopolization of the market is more efficient scenario than a fully competitive one. Hence, the gains from coordinated joint research far outlast the possible loss from monopolization of the market.