R&D, free entry, and social inefficiency

We employ a three-stage game model with cost-reducing research and development (R&D) that is subject to spillovers to consider the problem of excess entry under freeentry equilibrium relative to the social optimum. Firms choose to enter or exit a market in the first stage, choose R&D in the second stage and output in the final stage. Results show that there is socially inefficient or excessive entry in equilibrium. However, we uniquely demonstrate that research spillovers hold the key to whether established results regarding socially inefficient entry hold. Specifically, excessive entry occurs as long as research spillovers are relatively small, but this is not necessarily the case with large spillovers. Some policy implications are discussed.