Technology, R&D, and Efficiency Chapter 11W McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Invention, innovation, and technological diffusion Furthering technological advance Optimal amount of R&D Benefits from innovation Market structure and technological advance Technological advance and efficiency 11W-2

Technological Advance Occurs in the very long run Occurs in response to incentives Arises from firm rivalry Firms seek new profit opportunities 11W-3

Invention-Innovation-Diffusion Three step process Invention –Patent Innovation –Product innovation –Process innovation Diffusion Requires R&D expenditure 11W-4

U.S. R&D Expenditures Source: National Science Foundation Basic Research Applied Research (invention) 4% 22% 74% Development (innovation and imitation) Composition of business outlays W-5

Source: National Science Foundation R&D Expenditures Total R&D expenditures as a percentage of GDP, 2006 Sweden Japan United States Germany France Canada United Kingdom Italy Russia 11W-6

Role of Entrepreneurs Entrepreneurs –Bear financial risk Other innovators Forming start-ups Innovating within existing firms Anticipating the future Exploiting university and government scientific research 11W-7

Firm’s Optimal R&D Amount Marginal benefit and marginal cost Sources of funds –Bank loans –Bonds –Retained earnings –Venture capital –Personal savings Interest-rate cost of funds Expected-rate-of-return 11W-8

$ Expected rate of return, % R&D millions Interest Rate cost of funds, % Expected Rate of Return, r And Interest Rate, i (Percent) Research and Development Expenditures (Millions of Dollars) r = i i r Firm’s Optimal R&D Amount 11W-9

Three important points Optimal vs. affordable R&D Expected, not guaranteed, returns Adjustments Firm’s Optimal R&D Amount 11W-10

Increased Profits Increased revenue via product innovation –Importance of price –Unsuccessful new products –Product improvements Reduced cost via process innovation 11W-11

Increased Profits Total Product Average Total Cost Units of LaborUnits of Output TP 1 TP 2 ATC 1 ATC $ Innovation increases TP and decreases ATC Making greater production possible at lower costs 11W-12

Imitation and R&D Incentives Imitation problem Fast-second strategy Benefits of being first –Patents –Copyrights and trademarks –Brand-name recognition –Trade secrets and learning by doing –Time lags –Profitable buyouts 11W-13

Distribution of U.S. Patents Source: U.S. Patent and Trademark Office Top 10 foreign countries Number of U.S. patents, Japan (658,827) Germany (295,110) U.K. (123,371) France (110,839) Canada (77,594) Taiwan (58,162) Switzerland (52,201) South Korea (44,125) Italy (43,668) Sweden (38,456) 11W-14

2005 U.S. R&D Expenditures Source: National Science Foundation Business R&D Expenditures (Billions of 2000 Dollars) Year Business R&D Expenditures 11W-15

Role of Market Structure Which type of market structure is best suited to technological advance –Pure competition –Monopolistic competition –Oligopoly –Pure monopoly 11W-16

Inverted-U Theory More CompetitionLess Competition Concentration Ratio (Percent) R&D Expenditures as a Percentage of Sales A “loose” oligopoly supports the optimum R&D spending 11W-17

Technological Advance and Efficiency Productive efficiency –Increasing productivity of inputs Allocative efficiency –A more-preferred mix of goods and services Creative destruction 11W-18

Key Terms technological advance very long run invention patent innovation product innovation process innovation diffusion start-ups venture capital interest-rate cost-of- funds curve expected-rate-of- return curve optimal amount of R&D imitation problem fast-second strategy inverted-U theory of R&D creative destruction 11W-19

Next Chapter Preview… The Demand For Resources 11W-20