In this project, we shall use both microeconomic theory and laboratory experiments to investigate the relation between the intensity of competition and investment, which can be understood broadly, including for instance research and development R&D, managerial effort and firms' investments into worker training. Theoretical considerations will be necessary to organize earlier research in a consistent framework. The existing literature uses many different approaches to deal with the issues under consideration, with pertinent contributions from such diverse fields as industrial organization, growth theory and the theory of tournaments. The diversity of approaches notwithstanding, similar forces are at work. We shall therefore develop a reduced-form model to identify the general mechanisms influencing the relation between competition and investment decisions. Specifically, this model should improve our understanding of the circumstances under which there is a positive, negative or a non-monotone relation between competition and investment. Laboratory research is appropriate for several reasons. First, even though some of the relevant theoretical models are fairly complicated, the crucial arguments typically boil down to game-theoretic reasoning that is simple enough to be mapped into a laboratory environment. Second, they are the cleanest way to find out which of the strategic effects identified in the literature actually matter for decisions. Third, laboratory experiments allow us to clearly identify the effects of isolated parameter changes, including, for instance, the effects of more intense competition on investment. We therefore believe that they are useful to complement both theoretical and empirical research. Specifically, the project will deal with three sets of experiments. First, we shall analyze the effects of increasing numbers of players on individual cost-reducing investments, focusing on a simple Cournot model where theory predicts a negative relation between the number of players and investments. We hypothesize that, in spite of this prediction, the relation will be of an inverted-U shape in laboratory experiments, with the negative (Schumpeterian) effects of too much competition on the gains from investment being partly outweighed by a complacency effect of too little competition. A complementary experiment will deal with a case where theory already predicts such an inverted-U shape. Second, we shall deal with situations where the number of players is fixed and the intensity of competition corresponds to more basic properties of the payoff structure. In an oligopolistic context, these properties will reflect parameters such as the degree of substitution, market size, elasticities, etc. which are typically associated with the intensity of competition. Several conceivable theoretical models suggest an inverted U-relation between competition and investment in these situations. Finally, we shall analyze cases where the market structure and the investment behaviour are jointly endogenous, whereas fundamental parameters are varied so as to reflect competitive intensity. Unlike in the other two cases, it may be necessary to develop a theoretical model which we can put to the test here.
