Firm behavior and the externalities of technological leadership

A simple two firm model in which technological knowledge lies in an existing product's attribute is analyzed. Accordingly, the technologically leading firm, the firm whose current product is more advanced, produces a knowledge externality. The technologically less advanced firm may take advantage of the externality, by learning the technology and embarking on its own development plan. If the follower instead just imitates the leader's product, the externality is likely to have an adverse effect on the imitator, reflecting the notion that a larger technological gap makes imitation more difficult. Comparative statistics experiments reveal among other things that greater initial technological gaps encourage technological progress if the follower imitates. As a result, the introduction of a patent system in this case would inhibit technological progress.