Modelling the Process of Innovation

How important is uncertainty in modelling the process of innovation? Discuss the hypothesis that some degree of market power is necessary to achieve high rates of technical progress.

How have economists analysed the process of innovation? What are the implications for understanding the nature of competition?

Uncertainty

There are three main types of uncertainty demonstrated in innovation: market, rivalry, and technical uncertainty. Market uncertainty concerns about the impact of the technology when it hits the market, i.e. by how much will a process innovation reduce costs, what sort of demand curve will the new product attract? Rivalry uncertainty concerns about the rival’s reaction to the innovation, whether they will imitate or retaliate, and how fast is the process of diffusion in the market. The technical uncertainty is whether R&D will successfully generate a new technology and, if so, when. The other two issues for the innovative firm are: appropriability and timing. Any firm engaged in inventive activity will consider the appropriability of the results of its activity, i.e. how far will these results be internalised and how far will they constitute a public good. Also, timing is very important. This is most obvious in the so-called “patent race” in developing new technologies. While there are obvious advantages in being first, development programmes have a significant learning dimension, and speeding up development may incur excessively increasing costs. So when the firm is deciding when to adopt a new process, it has to decide whether to adopt earlier to gain competitive advantage over rivals, or to adopt later when teething troubles have been eradicated.

Schumpeter

Uncertainty is fundamental in Schumpeterian theory of innovation. Schumpeter (1934, 1939, 1942) proposed the idea that monopoly power and large scale of firm were the ideal vehicles for generating technical advance. His basic argument in favour of large firms is that they have the...