Optimal diversity: Increasing returns versus recombinant innovation

• Published in: Journal of economic behavior & organization Vol. 68; no. 3; pp. 565 - 580
• Main Author: van den Bergh, Jeroen C.J.M.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.12.2008; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Economic Behavior & Organization
• Subjects: Balance; Balance Disparity Distribution Economies of scale Efficiency Evolution Exploration versus exploitation Investment theory Learning R&D; Disparity; Distribution; Diversity; Economics; Economies of scale; Efficiency; Endogenous; Evolution; Exploration versus exploitation; Innovation; Innovations; Investment returns; Investment theory; Learning; Markets; R&D; Specialization; Spillover effect; Studies; O31; Q42; Exploration versus exploitation; Learning; R&D; Efficiency; Q28; Distribution; Economies of scale; Evolution; Investment theory; Disparity; Balance; B52; Social Sciences & Humanities
• ISSN: 0167-2681; 1879-1751; 0167-2681
• DOI: 10.1016/j.jebo.2008.09.003

Choices regarding diversity play an important role in economics and innovation management, but often remain implicit. Once made explicit, the objectives of efficiency and diversity are usually posed as in conflict, as efficiency relates positively and diversity negatively to various increasing returns to scale in markets. Such a perspective, however, neglects the benefits of diversity in terms of realizing system improvements through recombinant innovation or spillovers. The latter implies a contribution of diversity to long-term efficiency. Dominant economic approaches that address diversity, such as option value and real options theories, regard benefits of diversity as exogenous. This paper proposes a simple model of variable, endogenous diversity to analyse the optimal balance between increasing returns to scale and recombinant innovation. It is discussed under which conditions one of four solutions is optimal: complete specialization regardless of which option, complete specialization in one specific option, symmetric diversity (perfect balance), and asymmetric diversity. The results give rise to a number of policy insights.