Chapter 26 – Technology, R&D and Efficiency
Invention Innovation and Diffusion
In the long run, technology is constant but firms can change their plans and are free to enter and exit industries
Very long run – tech can change and firms can develop and offer new products
Invention - the discovery of a product or process through the use of imagination, Patent – the exclusive right to produce and sell any new and usefull process, machine or product for a length of time
Innovation - The first use of an invention, a process, a new business venture etc. Either product or process innovation
Allows firms to leapfrog over other firms, existing firms have a strong incentive for R&D
Diffusion – the spread of an innovation through imitation or copying
R&D expenditures
US firms channeled 72% of R-D funds towards development, 22% on applied research and 6% to basic research
Modern View of Tech Advance
Modern economists see capitalism as the driving force of technological advance, even advances in pure science are often motivatied by commercial ventures
Role of Entrepreneurs and Other Innovators
Entrepreneur – risk bearer
Other innovators – other people in R-D that don’t bear risk
Forming Start-ups
Focus on starting a new idea from scratch
Innovating with existing firms
Often pay innovators bonuses for innovation, have spinoff firms for R-D
Anticipating the Future – try to gauge how tech will develop
Exploiting University and Government Scientific Research
The 6% allocated to basic scientific research is small because that research can not be capitalized on
A Firm’s optimal amount of R-D
Expand an activity until Marginal Benefit = Marginal Cost
Interest Rate Cost of Funds
Bank Loans – The cost of using the funds is the interest paid to the lender, The marginal cost is the interest rate for each additional dollar
Bonds – May be able to raise funds by selling bonds. Cost is the interest paid to the lenders-the bondholders
Retained Earnings – Well established firms may be able to draw on company savings
Venture Capital – Part of household savings that finance a startup in exchange for shares in the profit
Personal Savings – entrepreneurs savings, the marginal cost is the foregone interest rate
Interest rate cost of funds curve - A graph of interest rate vs amount borrowed
Expected rate of return
Marginal benefit is the expected profit form the last dollar
Expected-rate-of-return curve – Marginal benefit of each dollar of expenditure on R-D
Slopes downward b/c diminishing rate of returns
Allocates money to have the highest rate of return
Optimal R-D Expenditure
Interest-rate-of-return curve and expected-rate-of-return curve intersect at the Optimal amount of R-D (where rate of return and interest rate are equal)
Optimal vs Affordable – R-D may be affordable beyond the optimal amount
Expected, not guaranteed returns – they are an informed gamble
Adjustments – Adjust the R-D expenditure when return on various projects Change
Increased profit via Innovation
Increased Revenue via Product Innovation
Consumers purchase the highest marginal utility per dollar
Consumers will buy a new product only if it increases the total utility they obtain from their limited incomes
Important factors – Importance of price, Unsuccessful new products – R-D is wasted, Product improvements
Reduced Cost via Process Innovation – better processes lower ATC and increase TP (total product)
Imitation and R-D incentives
Imitation problem – if a rival company copies a product then the first companies R-D profits are diminished
Fast-second strategy – a dominant firm may let little companies do the R-D and then copy them quickly
Benefits of being first
Patents, Copyrights and trademarks, Brand name recognition, Trade Secrets and Learning by doing – ie Coke recipe, Time lags – have some time to make a big profit, Profitable buyouts – small company may be purchased for a lot of money
Role of Market structure
Market structure and Technological Advance –
Pure competition – provides an incentive to develop, expected return from R-D may be much less, in highly competitive firms such as agriculture, development comes from outside (gov’t),
Monopolistic Competition – Strong profit incentive to innovate, unique products = monopoly, most monopolies are small so its tough for them to get capital for R-D
Oligopoly – Can finance, can maintain economic profit, broad scope offsets the misses, however Oligopoly breeds complacency, competing with itself
Pure Monopoly – little incentive for R-D, only to reduce the risk of being blindside by a new development
Inverted U Theory
Graph of R&D expenditures vs Concentration ratio is an inverted U
Low concentration firms are competitive, with easy entry
High concentration – monopoly profit is already pretty high and R-D won’t add much to the profit
Market Structure and Technological Advance: the Evidence
Best mix is Oligopoly with smaller firms
Technological Advance and Efficiency
Productive Efficiency – Enables society to produce the same amount of a particular good or service while using fewer scarce resources, freeing the unused resources to produce something else
Allocative Efficiency – New product gives more utility/dollar, Profit-maimizing monopolist restricts output to keep its product price above marginal cost
Creative Destruction – Innovation can destroy monopolies, in CD, new products will put monopolistic industries for old products out of business
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