Knowledge Spillover Network and Optimal R&D Policy in Oligopoly

ABSTRACT This paper studies optimal R&D policy in a Cournot oligopoly with network‐based knowledge spillovers. Generalizing the standard two‐stage model of Kamien et al. (1992), we characterize the socially optimal policy by decomposing the net externality of private innovation into three channels: the market expansion effect, direct knowledge spillovers, and the market rivalry effect. Contrary to the standard duopoly results that subsidies achieve the second‐best allocation, we show that in oligopolies with more than two firms, the optimal policy becomes taxation when knowledge spillover rate is sufficiently low or the spillover network is sufficiently sparse. We further show that the tax‐optimal region survives in non‐regular networks including complete bipartite, core‐periphery, scale‐free, and spatial networks.