Explain the reasoning behind the inverted-U theory of R&D expenditures

Question

What will be an ideal response?

Answer 1

The theory suggests that R&D development is at its best with very low concentrations (pure competition) and very high concentrations (pure monopoly). R&D compared to sales is low in the case of purely competitive firms because the firms are relatively small in relation to the market, meaning it’s harder for those firms to engage in R&D. R&D compared to sales is low for monopolies because profits are already high for these firms and innovation is not likely to add much more to their profits. Moreover, innovations will likely involve costly renovations of plants. Finally the lack of competition provides monopolies with little incentive to innovate.
The optimum industry structure for R&D is one in which expected returns on R&D are high and financing is relatively inexpensive. These factors most frequently occur in industries where there are a few firms but not so few that smaller firms can’t provide viable competition. In sum, a ‘loose’ oligopoly structure is best for R&D.