Page 552 - Economics

CONFIRMING PAGES

PART SIX
484
Microeconomics of Product Markets
Summary

1. Technological advance is evidenced by new and improved increases net revenue sufficiently to yield a positive rate of
goods and services and new and improved production or return on the R&D spending that produced the innovation.
distribution processes. In economists’ models, technological 7. Process innovation can lower a firm’s production costs by
advance occurs only in the very long run. improving its internal production techniques. Such
2. Invention is the discovery of a product or process through the improvement increases the firm’s total product, thereby
use of imagination, ingenuity, and experimentation. Innova- lowering its average total cost and increasing its profit. The
tion is the first successful commercial introduction of a new added profit provides a positive rate of return on the R&D
product, the first use of a new method, or the creation of a spending that produced the process innovation.
new form of business enterprise. Diffusion is the spread of an 8. Imitation poses a potential problem for innovators, since it
earlier innovation among competing firms. Firms channel a threatens their returns on R&D expenditures. Some
majority of their R&D expenditures to innovation and imita- dominant firms use a fast-second strategy, letting smaller
tion, rather than to basic scientific research and invention. firms initiate new products and then quickly imitating the
3. Historically, most economists viewed technological advance successes. Nevertheless, there are significant protections
as a random, external force to which the economy adjusted. and potential benefits for firms that take the lead with R&D
Many contemporary economists see technological advance and innovation, including (a) patent protection, (b) copy-
as occurring in response to profit incentives within the rights and trademarks, (c) lasting brand-name recognition,
economy and thus as an integral part of capitalism. (d) benefits from trade secrets and learning by doing,
4. Entrepreneurs and other innovators try to anticipate the (e) high economic profits during the time lag between a
future. They play a central role in technological advance by product’s introduction and its imitation, and (f) the possibil-
initiating changes in products and processes. Entrepreneurs ity of lucrative buyout offers from larger firms.
often form start-up firms that focus on creating and 9. Each of the four basic market structures has potential strengths
introducing new products. Sometimes, innovators work in and weaknesses regarding the likelihood of R&D and innova-
the R&D labs of major corporations. Entrepreneurs and in- tion. The inverted-U theory holds that a firm’s R&D spend-
novative firms often rely heavily on the basic research done ing as a percentage of its sales rises with its industry four-firm
by university and government scientists. concentration ratio, reaches a peak at a 50 percent concentra-
5. A firm’s optimal amount of R&D spending occurs where its tion ratio, and then declines as concentration increases fur-
expected return (marginal benefit) from the R&D equals its ther. Empirical evidence is not clear-cut but lends general
interest-rate cost of funds (marginal cost) to finance the support to this theory. For any specific industry, however, the
R&D. Entrepreneurs and firms use several sources to fi- technological opportunities that are available may count more
nance R&D, including (a) bank loans, (b) bonds, (c) venture than market structure in determining R&D spending and
capital (funds lent in return for a share of the profits if the innovation.
business succeeds), (d) undistributed corporate profits 10. In general, technological advance enhances both productive
(retained earnings), and (e) personal savings. and allocative efficiency. But in some situations patents and
6. Product innovation, the introduction of new products, suc- the advantages of being first with an innovation can increase
ceeds when it provides consumers with higher marginal utility monopoly power. While in some cases creative destruction
per dollar spent than do existing products. The new product eventually destroys monopoly, most economists doubt that
enables consumers to obtain greater total utility from a given this process is either automatic or inevitable.
income. From the firm’s perspective, product innovation

Terms and Concepts

technological advance process innovation optimal amount of R&D
very long run diffusion imitation problem
invention start-ups fast-second strategy
patent venture capital inverted-U theory of R&D
innovation interest-rate cost-of-funds curve creative destruction
product innovation expected-rate-of-return curve

9/8/06 11:00:57 AM
mcc26632_ch24_467-486.indd 484 9/8/06 11:00:57 AM
mcc26632_ch24_467-486.indd 484