Question

Consider an industry where demand has constant price elasticity and firms compete in output levels. In an initial equilibrium, both firms have the same marginal cost, c. Then Firm 1, by investing heavily in R&D, manages to reduce its marginal cost to c’ < c; a new equilibrium takes place. (a) What impact does the innovation have on the values of H and L? (b) What impact does the innovation have on consumer welfare? L： Lerner index H: herfil index

Answer 1

(a) Relationship between ‘product market competition’ and innovation is measured by the Lerner index, which is given by the price-cost margin over the price.

On a firm-level the use of the Lerner Index is best, however I feel that with the industry level analysis conducted Herfindahl index or concentration ratios are more suitable measure, because they account for the concentration of the industry not the firm individually.

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consumer choice
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(b) Innovation means “making changes to something established".

Innovation and Dynamic efficiency

Dynamic efficiency focuses on changes in available in a market together with the quality/performance of goods and services that we buy. Innovation can stimulate improvements in dynamic efficiency, always providing that the innovations that come to market are appropriate in satisfying our changing needs and wants.

Innovation can be a barrier to entry in markets. Property rights embedded in product innovations might be protected by patent laws. Austrian economist Joseph Schumpeter stated that innovation is the primary cause of economic progress and development. Innovation is a process of 'creative destruction' in which old ways of doing things are repeatedly destroyed and replaced by new, better ways.

Consumers stand to gain from such innovation in that they should be able to expect lower prices. This increases their real incomes.

Diagramatically,

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