Econ 165 22. R_D and Innovation

Econ 165 22. R_D and Innovation - R&D and Innovation...

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1 R&D and Innovation Solow (1956) established that innovation is the main driver of economic growth, which is the main cause of welfare improvements in the long run Thus, the development of new goods and services and improved production processes is much more important for improving long-run profitability and social welfare than efficient pricing practices Introducing research and development (R&D) and innovation into IO models changes many of the managerial and policy conclusions, and we need to re-think how to characterize industries As we have seen, most public policies in IO are structured with the basic goal of creating a market that is closer to the perfectly competitive ideal, whose main virtue is efficient prices
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2 Schumpeter and Creative Destruction Schumpeter (1942) believed that innovation causes most markets to evolve in a characteristic pattern There are periods of relative stability, when firms that possess superior products, technologies, or organizational capabilities earn positive economic profits These periods are punctuated by fundamental shocks or discontinuities that destroy old sources of competitive advantage (profits above the norm) and replace them with new ones The entrepreneurs who exploit the opportunities these shocks create achieve positive economic profits during the next period of stability
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3 The Long-Run Performance of the Economy According to Schumpeter, the process of creative destruction implies that static efficiency – the optimal allocation of society’s resources at a given point in time – is less important than dynamic efficiency – the achievement of long-term growth and technological improvement What really counts is competition between new products, technologies, and organizational techniques, not price competition (1942, pages 84- 5): “This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether [price] competition in the ordinary sense functions more or less properly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff”
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4 Policy and Managerial Implications Schumpeter’s ideas have been used to defend monopoly, on the grounds that high economic profits are a necessary reward to encourage innovation, which results in higher long-run growth Policy analysis should focus more on the impacts of policies on innovation and less on the impacts on prices and current welfare A key managerial implication is that even competitive advantages based on inimitable resources or capabilities or early-mover advantages are vulnerable in the long run as new technologies arise, tastes change, or government policy evolves Firms must manage to bridge the discontinuities that characterize creative destruction if they are to succeed over the very long run
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5 Implications for Desirable Market Structures and Policies
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Econ 165 22. R_D and Innovation - R&D and Innovation...

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