A well established result in the R&D literature is that when imitation is easy there will be generally underinvestment due to the free-rider problem. This paper shows that a public firm can be used in tackling the problem of underinvestment. We find that (i) in a mixed duopoly the public firm invests more in R&D than the private firm, (ii) in the mixed duopoly the private firm reduces its R&D investment relative to the private duopoly, while the public firm spends relatively more in R&D, (iii) relative to the social optimum, in the mixed duopoly the public firm overinvests while the private firm underinvests in R&D. A social welfare comparison between the private and the mixed duopoly proves ambiguous. By way of an example, using a quadratic R&D function, we show that depending on the size of the innovation, social welfare in the mixed duopoly can be higher than in the private duopoly.
Available at: http://works.bepress.com/joanna_poyago_theotoky/20/