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

2. 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

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

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

5. 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 2006 11W-5

6. Source: National Science Foundation 012345 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

7. 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

8. 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

9. 18 16 14 12 10 8 6 4 $10 20 30 40 50 60 70 80 8888888888888888 20 16 12 8 4 0 20406080100 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

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

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

12. Increased Profits Total Product Average Total Cost Units of LaborUnits of Output 2500 2000 1000 TP 1 TP 2 ATC 1 ATC 2 2000 2500 $5 0 4 0 Innovation increases TP and decreases ATC Making greater production possible at lower costs 11W-12

13. 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

14. Distribution of U.S. Patents Source: U.S. Patent and Trademark Office Top 10 foreign countries Number of U.S. patents, 1963-2006 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

15. 2005 U.S. R&D Expenditures 1980 - 2006 Source: National Science Foundation Business R&D Expenditures (Billions of 2000 Dollars) Year Business R&D Expenditures 11W-15

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

17. Inverted-U Theory More CompetitionLess Competition 0257510050 Concentration Ratio (Percent) R&D Expenditures as a Percentage of Sales A “loose” oligopoly supports the optimum R&D spending 11W-17

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

19. 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

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