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EC 261Management of New Technology

Myra MohnenEmail: [email protected]

Office Hours: Thursdays 2.30–3.30pm (5B.336)Lecture: Thursday 12.00–2.00pm (5S.4.19)

2017

INTRODUCTION

Myra Mohnen EC116 April 11, 2017 1 / 55

Course materials

• Lectures: Thursdays 12.00–14.00 (5S.4.19)• There are no classes for this module• Lecture slides will be posted online on Online Resource Bank

(ORB) in advance of the lecture.• The slides are designed for you to print them out prior to the

lecture and make notes in the margins.• There is no required text for the course. The lecture notes

constitute the core material.• Additional reading: see references in the outline


Formative Assessment

• Assessment: coursework (term paper) and May/Juneexamination

• Exam questions mostly essay–type but some analyticalproblem–solving questions as well.

• Titles of term papers available on ORB• The aggregate mark for the course is the greater of the

following two numbers:(i) (0.5 x coursework mark) + (0.5 x exam mark)(ii) exam mark


Questions• Are innovation market failures large enough to justify public

support for private innovation?• What types of institutional arrangements are best suited to

address different types of innovation market failures?• subsidies• tax credits• provision of public R&D resources to work with the private

sector• Competition policy (cooperative R&D)• patent policy• procurement policy• trade policy

• What are the implications of globalization of product andfinancial markets for the design of publicinnovation–supporting policy?

• How close to the final product market should public support betargeted?

• How can government ensure that its support exerts maximumleverage on private investment?Myra Mohnen EC116 April 11, 2017 4 / 55

Overview

We will examine a variety of issues in the creation, protection,purchase and sale of new technologies

Introduction

1. The Neoclassical Basics of Technology Change. Innovation andGrowth2. Endogenous Growth ModelsThe Economics of Knowledge

3. Main failures4. Measuring knowledgeSources of Technological Change

5. Sources of technological change


Overview

Policies to Promote Innovation

5. Intellectual Property6. Licensing Agreements7. Government subsidies of R&DDiffusion of Knowledge

8. Technology transfer9. Theory of diffusionPolicy Issues

10. Globalization and technology11. Innovation, energy, climate change


Motivation

• Innovation in science and technology play an important role ineconomic growth

• Thus, it is useful to understand what factors influence thedevelopment of technology

• In general, economists study the allocation of scarce resourcesIn this course, the scarce resource is the effort utilized in thescientific processThis could be money investment in R&D, labor efforts ofscientists and engineers, etc..


Research questions

1. What determines how much effort is invested into thescientific process?How do firms (or governments) decide how much to invest inR&D?How do they decide which projects to invest in?How do they decide which technologies to use?

2. How does government policy affect this process?Why is intervention necessary?How much money should the government spend on R&D?Should it subsidize private R&D?How strong should intellectual property rights be?

3. What effect does this research have on economic well–being?4. How does globalization affect the outcomes of technological

progress?


The importance of technology

• When economist look at the effects of science and technology,we look at productivity

• Productivity is the amount of output per unit of input• Examples

1. Labor productivity: output per worker2. Total factor productivity: a measure of output per unit ofcombined inputs

• Increases in productivity are important because smalldifferences in growth rates lead to large long term results


Technological Change

Three “parts" to technological change.1. Invention: the initial development of an idea. Could be

represented, for example, by a patent.2. Innovation: adopting the invention for commercial use.3. Diffusion: the spread of the new innovation throughout the

economy.


Policy relevance• Different policies affect different parts of the process• Government intervention in science and technology can be

justified by market failures.• Knowledge is a public good.• There are positive spillovers from the creation of knowledge for

which firms are not rewarded.! underinvestment in R&D is likely.

• One role of government policy is to encourage invention andinnovation.

• Patent protection allows firms to capture spillovers.• Tax subsidies lower the cost of R&D.• Because some knowledge is not rewarded in the marketplace,

or because widespread dissemination of some knowledge issired, the government may perform R&D directly.

• Government policy can also encourage diffusion• Patents make knowledge public• Government labs transfer knowledge to industry• Universities license technology to industry


LECTURE 1Neoclassical Approach to Technology


Neoclassical growth• Motivated by skepticism that a sustained rise in the savings

rate could lead to higher economic growth, and by Solow’swork on the “Solow residual" in the 1950s.

• Technological change replaced investment (growth of capital)as the primary engine of growth.

• The neoclassical model predicted that increased investmentcould lead to a spur of growth, but that growth rates wouldreturn to the earlier “natural" level.

• Investment leads to increases in the capital stock.• Over time the capital-labor ratio will rise. As a result, the

marginal product of capital will fall.• Steady state growth will result.

• This model provides the theoretical foundation for predictionsof convergence.

• Neoclassical theorists did realize that growth could besustained if technology progressed enough to maintain theproductivity of labor.

• However, neoclassical models treated technology as exogenous.Myra Mohnen EC116 April 11, 2017 13 / 55

Introduction: Neoclassical approach to technology

• A basic transmission mechanism for technology’s effect onwell–being goes through firms’ costs and the way costsinfluence firm behaviour

• Technology affects the level or shape of firms’ cost functionsand this, in turn, influences various decisions of firms (theoptimal scale of operation of a firm, its diversification acrossproducts...) as well as their performance.

• The cost structure also has implications for the marketstructure we observe in the economy.

• The cost structure and the market structure affect pricing andfirm profitability which, in turn, affect consumer and socialwelfare.

• This conception of technology has been used to build modelsof the effect of technological change on economic growth


Neoclassical Basics

• Production transforms a set of inputs into a set of outputs• What are inputs? Productive resources, such as labour and

capital equipment, that firms use to manufacture goods andservices. These are also called factors of production

• What are outputs? The goods and services produced by firms• Technology determines the quantity of outputs that can be

obtained from a given set of inputs


Production functions

•The production set shows the possible technological choicesfacing a firm

•The production function is a relationship between the inputsto the production process and the resulting output. It tells usthe maximum possible output that can be produced by thefirm for any given quantities of inputs

Q = f (L,K ) (1)

• A technically efficient firm is producing the maximum possibleoutput from its inputs

• Are firms technically efficient?


A production set186 C H A P T E R 6 I N P U T S A N D P R O D U C T I O N F U N C T I O N S

L, units of labor per year

Q, u

nits

of o

utpu

t per

yea

r

Technically inefficient

Technically efficient

B

A

C

D Q = f (L)

FIGURE 6.1 Technical Efficiency andInefficiencyAt points C and D the firm is technically efficient.It is producing as much output as it can with theproduction function Q ! f (L) given the quantityof labor it employs. At points A and B the firm istechnically inefficient. It is not getting as muchoutput as it could with its labor.

firm faces competition from other firms. Caves andBarton found that manufacturing firms in industries thatdid not face much competition from foreign importstended to be more technically inefficient than firms inindustries that were subject to significant import com-petition. They also found that firms in industries withhigh levels of concentration (sales concentrated in rela-tively few firms) tended to be more technically ineffi-cient than firms in industries containing a large numberof smaller competitors. These findings suggest that thepressure of competition—whether from imports orother firms in the industry—tends to induce firms tosearch for ways to get as much output as they can fromtheir existing combinations of inputs, thus moving themcloser to the boundaries of their production sets.

A P P L I C A T I O N 6.1

Competition Breeds Efficiency

Using data from the U.S. Census of Manufacturing (agovernment survey taken every 5 years to track manu-facturing activity in the United States), Richard Cavesand David Barton studied the extent of technical ineffi-ciency among U.S. manufacturers.2 For the typical man-ufacturer in Caves and Barton’s study, the ratio of actualoutput to the maximum output that would be attain-able given the firm’s labor and capital employment was63 percent. (In the notation used in the text, we wouldsay that Q/f (L, K ) ! 0.63 for the typical firm.) This find-ing implies that the typical U.S. manufacturer was tech-nically inefficient.

According to Caves and Barton, an important deter-minant of technical efficiency is the extent to which a

2Richard Caves and David Barton, Efficiency in U.S. Manufacturing Industries (Cambridge, MA: MIT Press,1990).

Because the production function tells us the maximum attainable output from agiven combination of inputs, we will sometimes write Q ≤ f (L, K) to emphasize thatthe firm could, in theory, produce a quantity of output that is less than the maximumlevel attainable given the quantities of inputs it employs.

besa44438_ch06.qxd 09/23/2004 04:19 PM Page 186


Isoquants

• An isoquant traces out all the combinations of inputs that arejust sufficient to produce a given level of output

• The shape of the isoquant indicates the degree ofsubstitutability of the inputs


8

L

K

0

●

●

Human-intensive

Robot-intensive

Q = 100

Example: Semiconductor chips: robot-intensive or human-intensive technology?

Neoclassical Basics, Cd


Example of production function

Labourers Robots Output per Day500 300 1601000 200 1601300 170 160500 350 1801000 220 1801300 190 180


Examples of technologies

1. Fixed proportion f (x1, x2) = min{x1, x2}2. Perfect substitute f (x1, x2) = x1 + x2

3. Cobb–Douglas f (x1, x2) = Ax

a1x

b2



Cobb Douglas

Cobb–Douglas Production FunctionFigure 6.16 illustrates isoquants for the Cobb–Douglas production function, whichis intermediate between a linear production function and a fixed-proportions produc-tion function. The Cobb–Douglas production function is given by the formulaQ = ALα K β , where A, α, and β are positive constants (in Figure 6.16, their values are100, 0.4, and 0.6, respectively). With the Cobb–Douglas production function, capitaland labor can be substituted for each other. Unlike a fixed-proportions production

6 . 4 S U B S T I T U TA B I L I T Y A M O N G I N P U T S 207

2 40

1

2

3

6H, quantity of hydrogen atoms

B

C

A

O, q

uant

ity o

f oxy

gen

atom

s

Isoquant for 3 molecules of water

Isoquant for 2 molecules of water

Isoquant for 1 molecule of water

FIGURE 6.15 Isoquants for a Fixed-Proportions Production FunctionTwo atoms of hydrogen (H) and oneatom of oxygen (O) are needed to makeone molecule of water. The isoquants forthis production function are L-shaped,which indicates that each additionalatom of oxygen produces no additionalwater unless two additional atoms ofhydrogen are also added.

10 20 30 40 500

10

20

30

40

50

L, units of labor per year

K, u

nits

of c

apita

l per

yea

r

FIGURE 6.16 Isoquants for aCobb–Douglas ProductionFunctionThe isoquants for a Cobb–Douglasproduction function are nonlineardownward-sloping curves.

Cobb–Douglas productionfunction A productionfunction of the formQ ! ALαKβ , where Q isthe quantity of output fromL units of labor and K units ofcapital and where A, α, andβ are positive constants.



Marginal Product

•The marginal product of an input is the change in outputthat results from a small change in an input holding the levelsof all other inputs constant

• How much more output will we get per additional unit oflabour?

MPL =�Q

�L

=f (L+�L,K )� f (L,K )

�L

(2)

(keeping K constant)

• How much more output will we get per additional unit ofcapital?

MPK =�Q

�K

=f (L,K +�K )� f (L,K )

�K

(3)

(keeping L constant)


15

L

K

0

Q = 100Q = 95

ΔLΔK


Marginal rate of technical substitution

•The marginal rate of technical substitution measures theadditional amount of an input the firm would require inexchange for using a little less of another input to produce thesame output as before

• It is reflected in the slope of the isoquant (holding outputconstant)

MRTSL,K =MPL

MPK= ��K

�L

(4)


11

L

K

0

Q = 100

ΔL

ΔK

●Q = 200


Deriving the marginal rate of technical substitution

It can be shown that the marginal rate of technical substitution canbe written as the ratio of marginal products:

Q = F (K , L) (5)

Taking the total derivative

@Q = FL@L+ FK@K = 0 (6)

�Q = MPL(L,K )�L+MPK (L,K )�K = 0 (7)

MRTS(L,K ) = ��K

�L

=MPL(L,K )

MPK (L,K )(8)


Properties of Technology

1. Increasing the amount of one input can never decrease output:�Q/�x � 0Implication: If �Q/�x > 0, then the isoquants must bedownward–sloping

2. Diminishing technical rate of substitution

Isoquants are convex to the origin (the MRTS diminishes aswe move down an isoquant)Intuition: the more you use of input A relative to input B , fora given level of output, the less productive each extra unit ofinput A becomes.

3. Law of diminishing marginal product

We often assume that output increases at a decreasing rate asany given input increases, keeping all other inputs constant. Inother words, we assume that MPi decreases as xi increases.


• The assumptions of a diminishing technical rate of substitutionand diminishing marginal product are closely related but notexactly the same.

• Diminishing technical rate of substitution is about how theratio of the marginal products – the slope of the isoquant –changes as we increase the amount of one factor and reducethe amount of the other so as to stay on the same isoquant.

• Diminishing marginal product is an assumption about how themarginal product changes as we increase the amount of onefactor, holding the other factor fixed.


What is technological progress?

• Technological progress shifts the production function byallowing the firm to achieve more output from a givencombination of inputs (or the same quantity of output withfewer inputs)

• Neutral technological progress shifts the isoquantcorresponding to a given level of output inwards, but leavesthe MRTSL,K unchanged along any ray from the origin.


19

L

K

0

Q = 100Q = 100



• Labour saving technological progress shifts the isoquantcorresponding to a given level of output inwards and results ina fall in the MRTSL,K along any ray from the origin.i.e. MPL falls relative to MPK .

• Why does this result in “labour saving"?• If relative input prices after the technological progress are the

same as before the technological progress, then L must fallrelative to K to restore the cost–minimising conditionMPL/MPK = PL/PK .


21

L

K

0

Q = 100Q = 100



• Capital saving technological progress shifts the isoquantcorresponding to a given level of output inwards and results ina rise in the MRTSL,K along any ray from the origin. I.e. MPL

rises relative to MPK .• Why does this result in “capital saving"?• If relative input prices after the technological progress are the

same as before the technological progress, then K must fallrelative to L to restore the cost- minimising conditionMPL/MPK = PL/PK .


23

L

K

0

Q = 100

Q = 100


Example: Chemicals in the UK.

• Evidence for materials-saving and capital-using technologicalprogress...

• In other words, evidence that technological progress hascaused

1. MPM to decrease relative to the MPOther

2. MPK to increase relative to MPOther

See: Suer, “Total Factor Productivity Growth and Characteristics of the Production Technology in the

UK Chemical and Allied Industries", Applied Economics, 27 (1995).


Returns to Scale

“How much will output increase when ALL inputs increase by aparticular amount?"

RTS = [%�Q]vs.[%�(all inputs)] (9)

• If a 1% increase in all inputs results in a greater than 1%increase in output, then the production function exhibitsincreasing returns to scale.

• If a 1% increase in all inputs results in exactly 1% increase inoutput, then the production function exhibits constant

returns to scale.• If a 1% increase in all inputs results in a smaller than 1%

increase in output, then the production function exhibitsdecreasing returns to scale.


26

Labour

Capital

0

Q = 100

Q = 1000

L1 2L1

K1

2K1

Increasing returns to scale


increases from K to λK ).10 Let φ represent the resulting proportionate increase in thequantity of output Q (i.e., the quantity of output increases from Q to φQ). Then:

• If φ > λ, we have increasing returns to scale. In this case, a proportionateincrease in all input quantities results in a greater than proportionate increase inoutput.

• If φ = λ, we have constant returns to scale. In this case, a proportionate in-crease in all input quantities results in the same proportionate increase in output.

• If φ < λ, we have decreasing returns to scale. In this case, a proportionateincrease in all input quantities results in a less than proportionate increase inoutput.

Figure 6.18 illustrates these three cases.Why are returns to scale important? When a production process exhibits increas-

ing returns to scale, there are cost advantages from large-scale operation. In particular,a single large firm will be able to produce a given amount of output at a lower cost perunit than could two equal-size smaller firms, each producing exactly half as much out-put. For example, if two semiconductor firms can each produce 1 million chips at$0.10 per chip, one large semiconductor firm could produce 2 million chips for lessthan $0.10 per chip. This is because, with increasing returns to scale, the large firmneeds to employ less than twice as many units of labor and capital as the smaller firmsto produce twice as much output. When a large firm has such a cost advantage oversmaller firms, a market is most efficiently served by one large firm rather than severalsmaller firms. This cost advantage of large-scale operation has been the traditional jus-tification for allowing firms to operate as regulated monopolists in markets such aselectric power and oil pipeline transportation.

210 C H A P T E R 6 I N P U T S A N D P R O D U C T I O N F U N C T I O N S

increasing returns to scaleA proportionate increase inall input quantities resultingin a greater than proportion-ate increase in output.

constant returns to scaleA proportionate increase inall input quantities simulta-neously that results in thesame percentage increase inoutput.

decreasing returns to scaleA proportionate increase inall input quantities resultingin a less than proportionateincrease in output.

1 20

1

2

L(a) Increasing Returns to Scale

Q = 3Q = 2Q = 1

K

1 20

1

2

L(b) Constant Returns to Scale

Q = 3

Q = 2Q = 1

K

1 20

1

2

L(c) Decreasing Returns to Scale

Q = 2

Q = 3

Q = 1

K

FIGURE 6.18 Increasing, Constant, and Decreasing Returns to ScaleIn panel (a), doubling the quantities of capital and labor more than doubles output. In panel (b), dou-bling the quantities of capital and labor exactly doubles output. In panel (c), doubling the quantities ofcapital and labor less than doubles output.

10Therefore, the percentage change in all input quantities is (λ − 1) × 100 percent.



Average Cost

Average Total Cost = Total Cost / Q• Average fixed cost continuously falls as production increases in

the short run, because K is fixed in the short run.• The shape of the average variable cost curve is directly

determined by increasing and then diminishing marginalreturns to the variable input (conventionally labor)


Economies of Scale

If input prices do not change with output, then:• When the production function exhibits increasing returns to

scale, the long-run average cost (= cost per unit of output)decreases with output.The average cost curve exhibits economies of scale.

• When the production function exhibits decreasing returns toscale, the long-run average cost increases with output. Theaverage cost curve exhibits diseconomies of scale.

• When the production function exhibits constant returns toscale, the long-run average cost curve is horizontal. Theaverage cost curve exhibits neither economies nor diseconomiesof scale.


Economies of Scale

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Nov 22 2010

From short to long: Economies of scale and the long-run average total cost curve

Published by Jason Welker at 10:50 am under Cost-minimization,Costs of production,Economies of scale,Law of diminishing returns

37 people like this. Be the first of your friends.LikeLike

Look closely at the two cost curves below:

The curve on the left is a firm’s short-run average total cost curve. The one on the right represents a firm’s long-run average total cost curve. See the difference?

I didn’t think so. The shape of a typical firm’s short-run and long-run ATC curves may in fact be identical. But there are some very important differences tounderstand about the short-run costs and long-run costs faced by firms.

The Short-Run: In microeconomics, we define the short-run as the period of time over which a firm’s plant size is fixed. The only variable resource is labor andraw materials, meaning that when demand increases for a firm’s product, the firm is able to increase employee work hours, hire more workers and use existingcapital more intensively, but it does not have the time to acquire new capital or expand factory size. Likewise, when demand falls for a firm’s products, it can cutback on work hours, fire workers, but cannot downsize its plants or factories.

The Long-Run: The long-run is defined as the variable-plant period. A firm can adjust the number of all its inputs: land, labor and capital. One way of thinkingabout the difference between the short-run and the long-run is imagining the long-run as several different short-runs spread out over a larger range of output. Thegraph below will illustrate this concept for you.

When we examine the long-run ATC more closely, it becomes apparent that there are in fact lots of little short-run ATC curves along the length of the long-runcurve. Each of the gray lines in the graph above represent a short-run period in which this firm opened a new factories. There are three distinct phases of thisfirm’s long-run ATC:


Decreasing returns to scale

• How can there be decreasing returns to scale if replication ispossible?

• The reason is that full replication may not be possible. Someinputs, such as entrepreneurial skills, may be in fixed supply.Or “organization" and “communication" in a firm may notincrease as much as K, L, etc after a certain firm size.

• Note: The AC curve may rise even without decreasing returnsto scale if input prices increase with output.

• Empirical evidence: most AC curves seem to be eitherL-shaped or to be first declining and then rising slightly atrelatively high levels of output.


31

P

Q

AC

Technological change shifts the average cost curve downwards and may also change its shape


Economies of Scope

• Economies of Scope exist when the total cost of producinggiven quantities of two (or more) goods in the same firm isless than the total cost of producing these quantities in two (ormore) single product firms.TC (Q1,Q2) < TC (Q1, 0) + TC (0,Q2)

• Economies of scope tell us that “variety" is more efficient than“specialisation"...

• In other words, it is less costly for a firm to add product 2 toits product line given that it already produces product 1 thanfor a different firm to start producing product 1:TC (Q1,Q2)� TC (Q1, 0) < TC (0,Q2)� TC (0, 0)


Accounting for Growth: Solow’s growth model

Assume constant returns to scale and perfect competitionthroughout.Let Q = f (K , L) , Q/L = f (K/L, L/L) , q = f (k , 1)where:q = Q/L is the average product of labour (labour productivity) andk = K/L is capital intensity

�q =�Q

�L

=�Q

�L

�K

�K

= MPk�K

�L

= MPk�k (10)

where � is change over timeNow let us add a technology parameter, a, so that q = af (k , 1)We then obtain: �q/q = MPk ⇤ k/f (k) ⇤�k/k +�a/a


Accounting for Growth: Solow’s growth model

• Intuitively, any percentage productivity growth, �q/q, can besplit into two parts:(i) the percentage growth due to an increase in capitalintensity for the same production function, MPk ⇤�k/k , and(ii) a percentage shift in the production function due totechnological change, �a/a.

• In empirical data, as we look at the relation of q to k acrosstime, we see (i) changes in q that are a result of movementsalong the production function due to changes in k as well as(ii) changes in q which are caused by shifts in the productionfunction due to technological progress. The problem is todistinguish between the two in the data.

• We’ll just give a graphical idea of the problem and Solow’smethod for detangling these effects...


350 k

q

●

●

Observation 1

Observation 2

We observe increased q per unit of k.We want to know why this has occurred.

We can draw our basic story on a simple graph with labourproductivity, q, as a function of the capital/labour ratio, k…


360 k

q

fearlier

●

●

Observation 1

Observation 2

●Technologicalchange

Increasedcapitalintensity

flater


370 k

q

●

●

Observation 1

Observation 2fearlier

●Technological change

Increasedcapital intensity

But if the production function is different…flater


40

Aggregate Production Function 1909-1949 according to Solow’s Data

0

0.623

0.686

1.275

k

1909

1949

Effect on q of technologicalchange

Effect on q ofcapital accumulation

2.06 2.7

●

●


• Solow (1957) demonstrated that technological advancementand increased human capital of the labour force accounted forbetween 80% and 90% of the annual productivity increase inthe US economy between 1909 and 1949, with increases in thecapital/labour ratio accounting for the remainder.

• Denison (1985) reached a similar conclusion for 1929-1982with:68% of productivity gains due to technological progress34% due to improved education of workers22% due to scale economies13% due to increased capital intensity. And also...-25% due to decreased work hours -4% due to governmentregulation.(Rest –> other factors)


Example: Labour Productivity in Europe

Growth in output per hour worked:• For several decades after World War II, productivity levels in

Europe and the US have been converging. In fact, averageproductivity of labour 1990-1995 was growing at 1.1% in theUS vs. 2.3% in EU-15.

• Since the mid-1990s, labour productivity growth rates havebeen lower in EU, resulting in an increase in the productivitygap: in manufacturing, EU-14 has fallen from 90% US level to81%, 1994- 2001.

• While there is considerable variance across EU, we do notobserve consistent “catching up".

See Sinkkonen, Bank of Finland, DP 4, 2005


• The Neoclassical model, while a bit of a black box, has usefulimplications for how we analyse the sources of economicgrowth.

• It also introduces a set of concepts for thinking about howtechnology affects firms and their costs. The link betweentechnology and costs can have public policy implications. Wewill extend these later to similar notions of technology’s effectson quality.

• Our next task will be to go inside the black box to see whatwe mean by “technology", and how this is created, protected,and used in firm strategy.


References


Documents

lecture1 - orb.essex.ac.ukorb.essex.ac.uk/ec/ec261/lecture_presentations/lecture1.pdf · How strong should intellectual property rights be? 3. ... • Investment leads to increases