This article constructs a model of R&D with heterogeneous firms. Each firm's probability of success is a function of its sunk and recurrent R&D expenditures. The social gains from an innovation are not fully captured by the successful firm. The comparison of the social optimum and the market equilibrium involves balancing spillover and crowding effects. Pigovian corrective policies, as well as strategic policies for a subset of colluding firms, are discussed.
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Avinash Dixit (1988) studied this question.
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