Economics 124/PP 190-5/290-5 Innovation and Technical Change

Economics 124/PP 190-5/290-5 Innovation and Technical Change Diffusion of innovations Prof. Bronwyn H. Hall

Outline – Diffusion (Oct. 26,28) • Introduction • Economic determinants of diffusion • Overview of some models • Factors affecting the pace of diffusion • Example: the dynamo and the computer Econ 124/PP 190-5/290-5

Diffusion • Dictionary definition: The spread of linguistic or cultural practices or innovations within a community or from one community to another • Course definition: The spread of an innovation throughout the economy or the relevant set of potential users – examples: • Almost all consumers – TV, indoor plumbing • ATM machines – banks and retail stores • Sometimes referred to as “adoption” • When looked at from the point of view of individual choice by consumers or firms Econ 124/PP 190-5/290-5

The historical view “in the history of diffusion of many innovations, one cannot help being struck by two characteristics of the diffusion process: its apparent overall slowness on the one hand, and the wide variations in the rates of acceptance of different inventions, on the other.” (Rosenberg, 1976, p. 191). Econ 124/PP 190-5/290-5

The s-curve for diffusion • Shows how the number of users of a new technology grows over time (usually measured as a share of potential users). • Begins trending upward very slowly • At some point becomes much steeper (as the technology spreads rapidly) • Eventually flattens out because there are fewer and fewer potential users that have not already adopted • Graph shows the diffusion of some major consumer inventions in the United States during the past 100 years. Econ 124/PP 190-5/290-5

U.S. diffusion of major inventions Econ 124/PP 190-5/290-5

Bottom-up view • Adoption from the point of view of adopter: • Investment under uncertainty • Once done, costs are sunk • Like an option • Adoption from the point of view of the innovator or supplier: • Marketing goal – reaching a new customer • Focus on network effects, either technological or social Econ 124/PP 190-5/290-5

Top-down view • Channel from innovation to economic growth mediated by diffusion, which can be surprisingly slow • need to understand process to understand why • Some examples • Diffusion of electricity required complete factory redesign; infrastructure • Diffusion of computing technology and internet • Productivity growth sometimes surges 20-30 years after initial introduction of new general purpose technology (GPT) Econ 124/PP 190-5/290-5

Economic determinants The adoption decision will depend on the factors that usually affect investment decisions: • Benefits • Costs • Risk and uncertainty/information • Environment and institutions – market and/or regulatory Econ 124/PP 190-5/290-5

Benefits depend on • Closeness of substitute technologies • Radio versus automatic clotheswasher • Mobile and landline telephones • Networks and standards (more later) • ATM adoption by banks • VHS/Beta • Wireless computing and 802.11b • Experience and Learning • Investment in adopter skills Econ 124/PP 190-5/290-5

Costs depend on • Price of new technology • Complementary investments • Infrastructure and other capital equipment • Training/skills • Scale • Due to fixed cost nature of adoption in many cases • Mechanical reaper in 19C (David on UK) • Cost of finance • Large body of literature on innovation investment where there is uncertainty Econ 124/PP 190-5/290-5

Uncertainty/information • New technology – less understood, more uncertainty about how well it works • Uncertainty about whether it will be successful (standards) • Benefits are a flow, costs are upfront => benefits may be more uncertain • The option to delay decision in order to acquire more information may cause delay in adoption • Luque (2002) – new manufacturing technology adopted more quickly in industries with lower sunk costs, lower uncertainty Econ 124/PP 190-5/290-5

Environment – market structure Size and/or market power of adopters: • Accelerates diffusion • Scale economies • Delays diffusion • Slower and less flexible Size and/or market power of suppliers: • Accelerates diffusion • Sponsoring a standard (e.g., IBM and the personal computer) – mobile telephone evidence • Delays diffusion • Higher prices • Less fear of market share loss to entry (see ATT in 1960s) Econ 124/PP 190-5/290-5

Environment - regulatory • Accelerates adoption • mandates pollution or safety standards • solves coordination problems in network industries • Delays adoption • Safety regulation, e.g., new pharmaceuticals and medical instruments, PVC pipe • Standard-setting process - telecommunications (ATT again) • New California law and lighting innovation? Econ 124/PP 190-5/290-5

Some empirical examples Econ 124/PP 190-5/290-5

Models – the s-curve • Heterogeneous adopters • Benefits have a unimodal distribution • Costs decline monotonically • Adopt when benefit>cost • Epidemics (spread of information) • Small share adopt • They encounter the remainder randomly; those contacted adopt • Implies 3-parameter logistic Both models => s-shaped curve for diffusion Econ 124/PP 190-5/290-5

Models - sunk costs • Adoption is investment under uncertainty • Compare an upfront cost with a stream of future benefits • =>adoption an absorbing state in the sense that once costs incurred, they are sunk • Decision is • Not“adopt or do not adopt” • But instead “adopt now or wait to decide later” • Real options models (Stoneman 2001) • Uncertain payoff is modelled as a stochastic process • If it reaches a high enough value (strike price), the option to invest is exercised. Econ 124/PP 190-5/290-5

Internet diffusion in Econ 124 • Computer ownership: • 1997, 80% of class • 2003, 100% of class • Internet use 1997 to 2003 • Total use increased • Recreational use relatively more important in 2003 • More classwork done at home • Web surfing increased more than email • University service improved a lot • => WTP (Willingness To Pay) decreased Econ 124/PP 190-5/290-5

Econ 124/PP 190-5/290-5

Economics 124/PP 190-5/290-5 Innovation and Technical Change