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In this paper, we analyse how R&D investment decisions are affected by R&D spillovers between firms, taking into consideration that more R&D investment improves the ability to learn from competing firms—the so-called absorptive capacity effect of R&D. Contrary to earlier studies, we show that absorptive capacity effects of own R&D do not necessarily drive up the incentive to invest in R&D. This only happens when the market size is small or the absorptive capacity effect is weak. Otherwise, firms will actually choose to cut down on R&D. Furthermore, absorptive capacity effects also increase the critical rate of spillovers that determines whether a research joint venture generates more R&D investment than a non-cooperative setting. Finally, we show that strong learning effects of own R&D are not necessarily good for welfare. Moreover, if the market size is large, welfare will be at its highest when the learning effect is small.
