DP5890 | The Dye Famine and its Aftermath: Knowledge Diffusion and Entry

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29/10/2006

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Abstract

A firm that introduces a new good enjoys monopoly profits for some initial period of time. What happens subsequently depends upon the relative strength of knowledge diffusion and increasing dominance. The first effect enhances challengers? ability to develop the product, erodes the incumbent?s monopoly power, while the second, which concerns the relative net cost of the incumbent to challengers in production, strengthens it. This paper exploits the near total disruption of imports of German dyes to the United States during World War I and the immediate post-War period, and the subsequent re-entry of the Germans to the market, to separately estimate the first effect. The results show that while (a) the probability of a dye was imported in 1913-1914 bore no relation to its year of discovery, (b) the probability it was produced in 1917 by the new American manufacturers was greater by one and a half percent per year, the earlier the year of discovery. Coupled with the estimated semi-elasticity of the probability of production with respect to the volume of imports in 1914, and assuming prospective profits were proportional to that volume, one obtains that every additional year since discovery decreased the expected cost of developing the dye by 19 to 25%. The paper shows, additionally, that after German imports were able to resume, the probability of a dye being imported in 1923, given that the Americans were already producing it, was independent of the year of discovery ? implying that the discovery year is an appropriate proxy for the amount of development relevant knowledge that had diffused through the industry.