Numerical Analysis of Markov-Perfect Equilibria with Multiple Stable Steady States: A Duopoly Application with Innovative Firms

This paper presents a numerical method for the characterization of Markov-perfect equilibria of symmetric differential games exhibiting coexisting stable steady states. The method relying on the calculation of ’local value functions’ through collocation in overlapping parts of the state space, is applicable for games with multiple state variables. It is applied to analyze a piecewise deterministic game capturing the dynamic competition between two oligopolistic firms, which are active in an established market and invest in R&D. Both R&D investment and an evolving public knowledge stock positively influence a breakthrough probability, where the breakthrough generates the option to introduce an innovative product on the market. Additionally, firms engage in activities influencing the appeal of the established and new product to consumers. Markov-perfect equilibrium profiles are numerically determined for different parameter settings and it is shown that for certain constellations the new product is introduced with probability one if the initial strength of the established market is below a threshold, which depends on the initial level of public knowledge. In case the initial strength of the established market is above this threshold, the R&D effort of both firms quickly goes to zero and with a high probability the new product is never introduced. Furthermore, it is shown that after the introduction of the new product the innovator engages in activities weakening the established market, although it is still producing positive quantities of that product.