Product liability, multidimensional R&D and innovation

This paper studies the effect of product liability cost on firms’ incentives to conduct R&D when innovation inherently consists a safety dimension and a novelty dimension. We consider a situation where a monopoly firm chooses both product novelty and product safety in an R&D stage followed by a production stage. While firms will invest more in product safety as product liability cost increases, their incentive for product novelty may increase or decrease, depending on the relative strengths of a demand-shifting effect and a cross-R&D effect identified in the model. Consequently, a higher product liability cost may decrease consumer welfare and total welfare. We extend the results to an oligopoly model with differentiated products and study the effects of competition. We find that equilibrium product novelty and safety levels decrease with the number of firms but exhibit non-monotonic relationships with the degree of product substitutability.