Abstract: When an upstream and a downstream firm exist in the market,vertical integration can increase the upstream R&D expenditure,the downstream output,and the industry profit.This paper studies the problem whether the upstream and downstream firms can sign a contract to increase the upstream R&D expenditure,the downstream output,and the industry profit to the level after the vertical integration.It is shown that,if the upstream and downstream firms play two-stage dynamic game,the contract is not a perfect Nash equilibrium.If the upstream and downstream firms play infinitely repeated game,the contract can be signed and abided.

Key words: R&D, vertical integration, contract, game