Lesson 6. TECHNOLOGY Physical Capital & Technology The Economics of Information Goods Technology and Economic Growth

1. PHYSICAL CAPITAL DEFINITION: - stock variable a collection of resources (machines, tools, infrastructures) gives production services which increase future income

TYPES of CAPITAL: 1. Fixed capital (in firms) 2. Infrastructures 3. Public equipment 4. Residential buildings TEMPORAL CONCEPT of CAPITAL DEPRECIATION and INVESTMENT - Physical - Replacement - Technological - Extension

TECHNOLOGY DEFINITION: - A collection of theoretical and empirical knowledge - Incorporated into the physical capital (machines) and the institutions (firms) - To produce goods and services

Scientific knowledge  Technology - INCORPORATED Technology - NOT INCORPORATED INFORMATION vs. KNOWLEDGE System of science and technology

2. THE ECONOMICS OF INFORMATION GOODS Information goods —> products whose value comes not from their physical characteristics but from the information they embody. Information goods have low marginal cost, however, because they have high fixed cost, they won't be created unless the producer can cover its cost of production by charging a price well above marginal cost. Like monopoly, this leads to an inefficiently low quantity of output.

A musical recording has high fixed cost and low marginal cost, a situation similar to natural monopoly. The profit-maximizing price, PM, is $5, the average total cost, ATCM, is $3, resulting in a per-unit profit of $2. The profit-maximizing music company behaves like a monopolist: Offering the good for free leads to a gain in total surplus of area E. Knowing, however, that it will be forced to provide the good for free is likely to lead the music company to forgo producing the good altogether.

Pricing Problems for Information Goods Information goods create a special tension. Monopoly is a bad thing, other things equal; it is inefficient to charge a price that is above marginal cost. But the expectation of monopoly profits is necessary to induce the company to produce the good at all. Indeed, economists generally agree that when it comes to information goods, a temporary monopoly may be the necessary price of progress. Why temporary? Because both law and natural forces tend to limit the duration of the monopolies associated with information goods.

Property Rights in Information A patent gives an inventor a temporary monopoly in the use or sale of an invention; a copyright similarly gives the creator of a literary or artistic work sole rights to profit from that work. By creating temporary monopolies, patents and copyrights facilitate the production of some information goods. When this legal protection is not available, producers of information goods often manage to establish temporary monopolies by exploiting first-mover advantages.

Network Externalities Many information goods are also characterized by network externalities: the value of the good to an individual is greater when a large number of people also use the good, e.g. fax machines. Network externalities cause positive feedback, in which either initial success or initial failure is self-reinforcing.

Network Externalities When network externalities are strong, a large proportion of consumers may not be willing to purchase a good unless the number of existing users exceeds a threshold network size. This leads to the critical mass effect, a sudden rapid increase in the network size. Network externalities also lead to tipping, in which a small initial advantage for one of two competing goods becomes self-reinforcing.

Critical Mass This figure illustrates how critical mass effects change the quantity demanded over time of a good with network externalities. The quantity demanded grows slowly until critical mass is reached; once reached the quantity demanded suddenly explodes.

Tipping This figure illustrates how tipping can affect the quantity demanded of two competing goods or technologies over time. The demand for one of the goods can suddenly explode as customers decide en masse to switch to that good and away from its competitor. Simultaneously, the demand for the competitor will suddenly fade.

Antitrust Policy and Setting Standards Information goods pose difficulties for antitrust policy because firms investing in new technologies may be engaging in aggressive tactics to establish monopolies, tactics that may or may not be legal. To facilitate network externalities, industries must coordinate on standards that let competing goods work together. Government can play a useful role both in helping an industry establish a standard and in helping it avoid getting trapped in an inferior standard, known as the QWERTY problem.

Examples Apple: network externalities that caused many users to stick with an inferior product that was widely used, especially given the fact that the superior alternative was considerably more expensive Microsoft: antitrust policy, firms investing in new technologies may be engaging in aggressive tactics to establish monopolies, tactics that may or may not be legal IBM

3. ECONOMIC GROWTH Solow model (technology as a public good) versus Models of endogenous growth Physical cap. + Human cap. + Technol. cap.: intentioned Individual firm: constant returns The whole economy: increasing returns

TECHNOLOGICAL SPREADING  technology => economic growth Technological spreading (“technoglobalism”):  trade of goods and services  international markets of patents Multinationals Cooperation between scientists and firms Domestic obstacles: Human capital, infrastructures Importation or imitation of technologies (problems)

Technological spreading in the world OECD Poor countries: Africa, Latin America Developed countries: Korea, Taiwan, Singapore, Hong-Kong, Malaysia, Thailand, Philippines, Indonesia, India, Brazil, China. REQUIREMENTS: Political and economical stability Human capital Patience, gradual and constancy