Market structure and dynamic efficiency What type of market structure (e.g. competitive, oligopolistic) is most desirable from the standpoint of bringing about technological innovation? The term dynamic efficiency ( or "technological progressiveness") means the comparative strength of the tendency among firms in a given market to innovate--that is, to contribute to process and product innovation in their industry.

Process and Product Innovation Process innovation : Development of new production techniques or methods of organization that result in reduced unit production cost. Examples: high speed printing, just-in-time inventory management, use of computer-guided robotics, continuous process manufacturing, use of hybrid seeds. Product innovation: The development and marketing of new or improved products. Examples: Cellular phones, pagers, improved software applications, baked tortilla chips, direct TV, compact disks, digital special effects, internal frame backpacks, electronic banking, antibiotics.

The Solow contribution 1 Robert Solow. "Technical Change and the Aggregate Production Function, " Review of Economics and Statistics, August Solow's contribution was to develop a methodology which made it possible to measure the contribution of various factors (labor, capital, technical change,... ) to productivity growth. A key finding: 80 percent of the change in labor productivity (output per worker per hour) in the U.S. from can be explained by "technical change,“ as opposed to capital accumulation or improvements in human resources.labor productivity

Output per worker per hour Capital/Labor ratio A B K PRPR PR’PR’ Function shifts due to innovation 0

Productivity-boosting innovations Engineering time and motion studies The assembly line The internal combustion engine Air conditioning The cotton harvestor The transistor Internet browser software Electronic bar coding/automated data capture

Joseph Schumpeter on structure and innovation 2 2 Joseph Schumpeter. Socialism, Capitalism, and Democracy (1942). Click here to read a quote.read a quote. Technical and organizational innovation is the key factor in bringing about secular improvements in the material standard of living. Firms (and entrepreneurs) are agents of innovation. Firms may achieve a dominant position as a result of a superior product, process, or business acumen. However, the fortunes of monopolistic (or oligopolistic) firms is perpetually under threat from aggressive, innovative rivals (see IBM). A public policy that has as its primary objective the promotion "allocative" efficiency is misguided.

What reasons are there to suppose that imperfectly competitive market structures would yield superior dynamic efficiency? Windfall profits realized by dominant firms supply the wherewithal to finance costly R&D projects. R&D may be subject to important economies of scale; thus the optimal size of the dynamic firm may be quite large. Firms must enjoy a dominant position in their market (or at least have a reasonable prospect of achieving a dominant position as a result of innovation) to take on the risk of costly and uncertain R&D projects. New knowledge (the output of investment in R&D) is appropriable (that is, is easily ripped off)--yet firms must be confident up front that their rights to intellectual property will be protected. But the protection of rights to intellectual property (by means of patent laws, for example) creates a barrier to entry.

Price Quantity D Supply curve if industry is competitive MR 0 Monopolist’s MC curve PCPC PMPM QMQM Dynamically efficient monopoly Back to Lesson 3