Using economic analysis, explain why the Singapore government is increasing its spending on Research and Development (R&D).

R&D is whereby a firm researches to develop new products of higher quality. Other firms will thus, benefit from the improvements of these new products, enjoying lower costs from higher efficiencies (this is an external benefit). This would mean that the all firms (both those that do R&D and don't) would benefit the same since the improvements of technology would be the same. This is why Marginal Social Benefit (MSB) is equals to Marginal Private Benefit (MPB). However, since the firms that undertake R&D have to use more resources to research and develop while the firms that don't undetake R&D don't have to use any resources, the Marginal Private Cost (MPC) would be larger than the Marginal Social Cost (MSC). Hence, the divergence in the cost curves. Since firms are unwilling to undertake R&D due to its high costs and that firms are able to wait for other firms to develop, there will be less firms undertaking R&D, resulting in an underproduction of research activities. Hence, R&D activities are an external benefit in production.
The graph above shows that MPC is greater than MSC. The point at which the firms maximise profits is when MPC is equals to MPB, which is at E1. The firms are thus producing an output of OQ1. This is smaller than the socially efficient output of OQ2where MSB is equals to MSC. There is thus an underproduction of Q1Q2 and it results in a welfare loss of the area E1E2X. This unequal allocation of resources is thus, a market failure.

The Singapore government is spending more on R&D so that producers would be given an incentive to increase R&D projects. The increase in spendings by the Singapore government will shift the S1 curve towards the right, making the output that is produced closer to the socially efficient output. This reduces the welfare loss and the area E1E2X will become smaller. Thus, the government is increasing its spending on R&D projects.

Suggest reasons why the government has increased R&D expenditure gradually.

Well, if the government increased R&D expenditure too quickly, there may be a presence of over-subsidies and even more firms would undertake R&D. This could result in the overproduction of R&D, resulting in another market failure. By increasing the R&D gradually, slowly but surely, the government would be able to obtain the socially efficient output and correct this market failure. The exact expenditure that should be spent on R&D is very difficult to monetize, thus it is better to be safe than sorry. :D

Responding to Jun Hao's answer...

R&D is not a public good because the firms that do not undertake R&D will also have to pay for the new and improved products to use them. This means that R&D is excludable and only those who have the money to pay for it will be able to use it. Thus, it is not a public good. However, if the firms do not have to pay for these new products and if every single firm will be able to use these products, then it can be considered as a public good since it would be non-excludable and non-rivalrous. So yeah . . .

Hurry and finish your PIs guys !
MINGYI :D

Labels: Merit, Research and Development