Product Innovation with Lumpy Investment

Abstract: This paper considers a firm that has the option to undertake product innovations. For each product innovation the firm has to install a new production plant. We find that investments are larger and occur in a later stadium when more of the old capital stock needs to be scrapped. Moreover, we obtain that the firm’s investments increase when the technology produces more profitable products. We see that the firm in the beginning of the planning period adopts new technologies faster as time proceeds, but later on the opposite happens. Furthermore, we find that the firm does not invest such that marginal profit is zero, but instead marginal profit is negative. Moreover, we find that if the time it takes to double the efficiency of technology is larger than the time it takes for the capital stock to depreciate, the firm undertakes an initial investment. Finally, we show that when demand decreases over time and when fixed investment cost is higher, that the firm invests less throughout the planning period, the time between two investments increases and that the first investment is delayed.