Incentives to invest and to give access to new technologies

We analyze the incentives of a vertically integrated firm, which is a regulated monopolist in the wholesale market and competes with an entrant in the retail market, to invest and to give access to a new wholesale technology. The new technology is unregulated and produces retail products of a higher quality than the old technology. If the innovation is non-drastic, the vertically integrated firm may be induced to give access to the entrant. Furthermore, if the innovation is non-drastic and small, a duopoly in the retail market is socially optimal, whereas if the innovation is nondrastic but large, a monopoly in the retail market is socially optimal. If the innovation is drastic, the vertically integrated firm does not give access to the entrant. If both firms can invest, but only one does, it is more likely that it is the entrant who invests. The impact on social welfare of the two firms investing, instead of just the vertically integrated firm, is potentially ambiguous.