Strategic R&D Investments with Uncertainty and Economic Welfare Toshihiro Matsumura ∗ Institute of Social Science, University of Tokyo December 27, 2002 Abstract I introduce uncertainty into the model of strategic cost-reducing R&D investments and reexamine welfare implications. I discuss two models. In one model an increase in expen- diture decreases production costs when R&D succeeds, and in the other model it increases probability of success. I show that two models yield completely different implications for tax-subsidy policies on R&D investments. In the former model equilibrium investment level is always too low form the viewpoint of social welfare, while in the latter model it can be either too low or too high and relatively risky (safe) investments should be subsidized (taxed). JEL classification numbers: L13 Key words: R&D, production substitution, uncertainty ∗ Correspondence address: Institute of Social Science, University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo 113-0033, Japan. Phone: (81)-3-5841-4932. Fax: (81)-3-5841-4905. E-mail: matsumur@iss.u-tokyo.ac.jp 1