Economic theorists have been of two minds on the relationship between monopoly power and innovation. Kenneth Arrow argued that competitors have more incentive to innovate than monopolists.
Others suggested that monopolists are more likely to encourage innovation.
A recent Minneapolis Fed staff report argues that both models implicitly assume that adoption of innovation is trouble-free. When “switchover disruptions” are incorporated into either model, theory shows that competitive environments are more favorable to innovation.
The crux of the argument: Because monopolists make higher profits than competitors, they have higher opportunity costs. Disruptive switchovers therefore pose a greater disincentive to innovation for monopolists.
Douglas Clement is a managing editor at the Minneapolis Fed, where he writes about research conducted by economists and other scholars associated with the Minneapolis Fed and interviews prominent economists.