INNOVATION ADOPTION AND WELFARE UNDER UNCERTAINTY

The incentives of firms to adopt a new process need not coincide with maximum expected consumer surplus or social welfare if there is uncertainty before the process is adopted, and if the only loss from failure is a fixed cost. In some cases, no firm will adopt an innovation likely to fail, although expected welfare is maximized if one adopts. In other cases, both firms will adopt an innovation likely to succeed, although expected welfare is maximized if one firm adopts. This occurs because rivalry between firms leads them to adopt together when total expected profits are higher if one firm adopts.