The aim of this paper is to investigate the firms' incentives to engage in process R&D under vertical industrial setting, when the raising rivals' cost effect is present. We show that R&D investment of the downstream duopoly firm raises the rival's marginal costs of production. The downstream R&D behavior can give rise to the symmetric investment games, i.e., the prisoner's dilemma, the deadlock game and the harmony game, between downstream competitors. If the costs of the R&D investments made by the downstream firms are large enough, the downstream firms can participate in the harmony game, which results in the investment hold-up or the creation of the R&D-avoiding cartel. For more R&D-efficient downstream firms, the downstream investment game can end up in the prisoner's dilemma or the deadlock game. In the prisoner's dilemma, both downstream firms invest in R&D, but such a behavior is not Pareto optimal. In the prisoner's dilemma, greed and fear make firms invest in R&D. In the deadlock game, both downstream firms invest in R&D, and such a behavior is Pareto optimal. The R&D investments are not induced by any social tension (greed or fear).
Research and development investments prisoner’s dilemma deadlock game harmony game