KTH/CESIS Working Paper Series in Economics and Institutions of Innovation
Persistence of Profits and the Systematic Search for Knowledge - R&D and profits above the norm
Abstract: Economic theory tells us that abnormal industry and firm
profits will not persist for any length of time. Any industry or firm
making profits in excess of the normal rate of return will attract entrants
and this competitive process will erode profits. A substantial amount of
research however, has found evidence of persistent profits above the norm.
Barriers to entry and exit are often put forward as explanation to this
anomaly. In the absence of, or with low barriers to entry and exit, this
reasoning provides little help in explaining why these above-norm profits
arise and persist. In this paper the association between profits and the
systematic search for knowledge is investigated. The results show that by
investing in research and development firms may succeed in creating
products or services that are preferred by the market and/or find a more
cost efficient method of production. Corporations that systematically
invest in research and development are, by doing so, offsetting the erosion
of profits and thereby have profits which persistently diverge from the
competitive return. It is argued that even in the absence of significant
barriers to entry and exit profits may persist. This can be accredited to a
systematic search for knowledge through research and development.
Keywords: Persistence of profits; research and development; industrial organization; (follow links to similar papers)
JEL-Codes: L00; L22; L25; O32; (follow links to similar papers)
17 pages, January 15, 2009
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