Saturday, November 1, 2008

Chapter 26

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 CompetitionStrong 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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