Cost-Reducing Investment, Optimal Procurement and Implementation by Auctions

Abstract

We analyze a model in which potential suppliers invest in research and development (R & D) and then compete for a procurement contract from a buyer. If the buyer is able to commit to a procurement mechanism before the investment stage, the full-information solution can be uniquely implemented by first-price and second-price sealed-bid auction mechanisms when the R & D technology exhibits decreasing returns to scale. If the procurement mechanisms and the levels of investment are chosen simultaneously, the full-information solution cannot be implemented. We discuss how the second-best equilibrium contract varies with the number of suppliers.

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