On the Diffusion of New Technology: A Game Theoretic Approach

Abstract

This paper is an attempt at a rigorous (albeit not exceedingly general) analysis of the diffusion of new technology. In particular, consider an industry composed of two firms, each using the current best-practice technology. The firms are assumed to be operating at Nash equilibrium output levels, generating a market price (given demand) and profit allocations. When a cost-reducing innovation is announced, each firm must determine when (if ever) to adopt it, based in part upon the discounted cost of implementing the new technology, and in part upon the behavior of the rival firm. If either firm adopts before the other, it can expect to make substantial profits at the expense of the other firm. On the other hand, the discounted sum of purchase price and adjustment costs may decline with the lengthening of the adjustment period as various quasi-fixed factors become more easily variable. Therefore, although waiting costs the firm more in terms of foregone profits, it may save money on the cost of purchasing the new technology. Thus the firm must weigh the costs and benefits of delaying adoption, as well as take account of its rival's strategic behavior.