LO1New and better products Better ways of producing and distributing those products Occurs over the very long runIncentive - the pursuit of profitsInvention, Innovation and Diffusion

Short RunNo change in technology, plant or equipmentLong RunNo change in technologyVery Long RunTechnology changes by R&D

LO1Invention, Innovation and Diffusion

Invention, Innovation and DiffusionInvention New product or processBased on scientific knowledgePatent protectionInnovationProduct or process innovationCant be patentedDiffusion Spread of innovation through imitation or copyingLO1

R&D ExpendituresAppliedResearch(invention)20%Developmentinnovation and imitation75%

BasicResearch5%Science Resource Statistics , National Science Foundation www.nsf.gov.LO2

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Modern View of Technological AdvanceCapitalism driving forceProfits incentiveRivalry among firms causeStarts from within the economyInternal to capitalismOld view A random event from outside the economyLO3

Role of EntrepreneursInitiator, innovator and risk bearerOther innovatorsForming start-upsInnovating within existing firmsAnticipating the futureExploiting university and government scientific researchLO3

A Firms Optimal Amount of R&DMarginal benefit and marginal costInterest rate cost of fundsBank loansBondsRetained earningsVenture capitalPersonal savingsInterest rate cost of fundsExpected rate of returnLO3

Expected Rate of ReturnMarginal benefit from R&DSlopes downward diminishing returns for R&D expendituresOptimal vs. affordable R&DExpected not guaranteed returnsAdjustmentsLO4A Firms Optimal Amount of R&D

A Firms Optimal Amount of R&D20

16

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0 20 40 60 80 100Interest Rate, i (Percent) R&D Expenditures (Millions of Dollars)iInterest-rate cost-of-funds curveLO3

R&DMillions$1020304050607080

Interest-Rate Cost of Funds, %88888888

A Firms Optimal Amount of R&D20

16

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0 20 40 60 80 100Expected Rate of Return, r (Percent) rExpected-rate-of-return curveR&D Expenditures (Millions of Dollars)LO3

20

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0 20 40 60 80 100R&D Expenditures (Millions of Dollars)Expected Rate of Return, r, and Interest Rate, i (Percent) r = iLO3A Firms Optimal Amount of R&D

Expectedrate ofreturn, %R&DMillionsInterestRatecost offunds, %

1816141210864$10203040506070808888888

Increased Profit via Innovation Increased revenue via product innovation Importance of price Unsuccessful new products Product improvements Reduced cost through product innovationLO4

Product A Price=$1Plot Points to Create Graph

Product B Price= $2New Product C Price= $4Utility Maximization with the Introduction of a New Product (Income = $10) Increased Profit via InnovationLO4

Unit of ProductMarginal Utility, UtilsMarginal Utility per Dollar(MU/Price)Marginal Utility, UtilsMarginal Utility per Dollar, MU/Price) Marginal Utility, UtilsMarginal Utility per Dollar, MU/Price) First1010/1=102424/2=125252/4=13Second88/1=82020/2=104848/4=12

Third77/1=71818/2=94444/4=11

Fourth66/1=61616/2=83636/4=9

Fifth55/1=51212/2=63232/4=8With $10 and choice of A and B(2A, 4B)With $10 and choice of A, B or C (1B, 2C)

Total ProductAverage Total CostUnits of LaborUnits of Output250020001000TP1TP2ATC1ATC220002500$5040Upward shift of thetotal product curveDownward shift of the average total cost curveIncreased Profit via InnovationLO4

Imitation and R&D IncentivesImitation problemFast-second strategyBenefits of being firstPatentsCopyrights and trademarksBrand-name recognitionTrade secrets and learning by doingTime lagsProfitable buyoutsLO5

Role of Market Structure LO5\ Pure competitionIncentive to innovate, but rate of return is lowMonopolistic competitionIncentive to differentiate, but profits are temporary

LO5

Role of Market Structure LO5\OligopolyLarge sizeAbility to finance R&D Barriers to entry Can foster R&DComplacency is a negative Pure monopolyLittle incentive to innovateDue to strong barriers to entry protecting profitsLO5

Inverted U Theory of R & DR&D Expenditure as a Percentage of SalesConcentration Ratio (Percent)More CompetitionLess CompetitionA loose oligopoly supports the optimum R&D spending0 25 50 75 100LO5

Technological Advance and Efficiency Productive efficiency Increasing productivity of inputs Allocative efficiencyA more-preferred mix of goods and services Creative destructionLO6

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