Question

Google is a large and existing firm that is considering developing a video chat platform. If Google goes forth with the development, there is a 50% chance of success. There are also three UVA students thinking of developing a similar platform. They as well have 50% chance of success. Both Google and the UVA students are deciding simultaneously whether or not to invest in research and development. If both players succeed in developing the video chat platform, they enter a price competition and they will both receive 0 revenues. If only one of the players succeeds in developing the platform, they receive revenue of $12. Development costs are $4, regardless of whether or not the endeavor was successful.

Consider now that the government wants to increase investment in R&D in order to induce growth and therefore wants to give firms who invest in developing new technology a $2 subsidy. As the government can only observe R&D expenditure of active listed firms, only Google would enjoy this subsidy. What would happen to the probability of inventing a new technology as a result of the subsidy? If the subsidy does not work, what can the government do in order to increase the probability of innovation?

Answer 1

The subsidy will increase the probability of inventing a new technology.

Suppose, if the probability of inventing is 0.5 , it will increase to 0.8.

Subsidies have a positive impact on the probability of inventing a new technology since it minimize the cost of inventing and therefore, the losses if the technology doesn't work.

If subsidy do not work, then government can reduce the cost of inventing, or the government should maximize the revenues generated from inventing a technology.

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