Economics of Innovation

Question 1

what are adam smiths view on invention?

Answer 1

division of labour drives invention an in turn leads to wealth creation

Question 2

What is schumpeters view on innovation?

Answer 2

creative destruction - innovator creates something whilst destroying something that already exists

Question 3

What is schumpeters definition of innovation?

Answer 3

innovation is introducing new commodities or better versions of existing ones, finding new markets and methods of production and introducing new forms of economic organisation.

Question 4

What is arrows view on innovation in the free market?

Answer 4

Underinvested as can only be appropriated to a limited extent

Question 5

What is the difference between innovation and invention?

Answer 5

Innovation is the successful exploitation of new ideas whereas invention is just the creatioin of new ideas . So innovation is the commercial application of invention.

Question 6

What are the misconceptions of technological change and innovation?

Answer 6

Technological change is a subset of innovation but innovation is not always concerned with technological change e.g innovation could be concerned with change in design or packaging. E.g Sonys various ‘Walkmans’ didnt use different tech it was just presented in different ways.

Question 7

What is;
a) pure process innovation
b) pure product innovation

Answer 7

a) changing the way the product is made without changing the product itself
b) creates a new or improved product without changing the production process

Question 8

How do product and process innovation often overlap?

Answer 8

improving the process often leads to incidental improvements in the product and making improvements to the product will require innovations in the production process.

Question 9

Give examples of process innovation and the effect?

Answer 9

Technological innovations - improve equipment
Production Management innovation - lean production, JIT
e.g GPS tracking for transport services, AI
Effect; increase efficiency and productivity = lowers costs

Question 10

Give example of Ford Motors process innovation of the assembly line?

Answer 10

Moving assembly lines which meant vehicles could be taken to the workers as opposed to workers moving to and around the vehicle. Vehicle could be built step by step.

Question 11

What type of innovation reduces fixed costs without changing marginal costs? Give example.

Answer 11

Capital saving innovation - reduces cost of capital equipment. E.g computers, Moores law says that the cost of computers are declining whilst the quality improves.

Question 12

What is the effect on total cost when fixed costs are reduced?

Answer 12

FIxed cost curve shifts down, so TC curve shifts down as TC= FC+VC. Slope of the curve is determined by VC and as this doesnt change the slope of TC remains.

Question 13

What is the effect on average cost when fixed costs are reduced?

Answer 13

AC = AFC+AVC. No change in MC (AVC). AC curve shifts down (U shape but particulary at lower levels of output) as decrease in AFC. Minimum efficient scale decreases (point at which MC crosses the bottom of AC)

Question 14

What type of innovation reduces marginal cost but has no effect on fixed cost?

Answer 14

Input saving innovation e.g division of labour

Question 15

What effect does decrease in marginal cost have on total cost?

Answer 15

Variable cost curve pivots down so TC curve pivots down at a shallower slope.

Question 16

What effect does a decrease in marginal cost have on average costs?

Answer 16

MC curve pivots down, consequently pivoting the AC down (especially at higher levels of production). New equilibrium where unit costs are lower but quantity produced is higher. Cost efficient with a higher MES.

Question 17

What type of innovation increases fixed costs but decreases marginal costs? What type of innovation might struggle with this?

Answer 17

Capital intensive process (introduce machines to replace labour). e.g chatbots
Small organisations might struggle due to the high initial upfront cost.

Question 18

Draw and explain the diagram that shows fixed costs increasing and marginal costs decreasing due to capital intensive production?

Answer 18

With labour intensive production there are 0 fixed costs (intercepts origin), MC is high however so steep slope of the curve. Capital intensive production has high initial fixed costs so intercepts Y axis at a higher point, has a less steep slope however as MC is lower. At a lower quantity of production should be labour intensive (left of vertical line) but at higher output economies of scale are introduced and lowers average cost.

Question 19

Give an example of an innovation that reduced marginal cost of producing other models/brands but increased fixed costs?

Answer 19

Toyotas flexible manufacturing system (which allows them to produce multitude of products under one roof) - in covid they devoted their efforts to producing ventillators. Allows for economies of scope

Question 20

Draw and explain the graph that shows increased fixed costs but lower MC of producing other models?

Answer 20

Metrics: total costs/number of models
Inflexible process = make product through same process at a higher MC (FC initially 0 but steep curve).
Flexible process = making new models requires upfront investment so FC high but MC lower due to economies of scope. If want to produce fewer models then should use inflexible process but if want to produce more models should use flexible as it brings total costs down. There is a minimum break even level here but after this is acheived the an unlimited variety can be acheived.

Question 21

Define;
a) economies of scale
b) economies of scope

Answer 21

a) unit costs decrease with increased output
b) unit costs decrease as scale of production increases (new brands and models including).

Question 22

Define;
a) radical innovation - give example

Answer 22

a) improvements that fundamentally alter the character of the product or process - can completely undermine the competence of the market leader. E.g PC was a radical innovation that undermined IBM’s dominance in the computer industry. It adopts the combinatorial view that reorganises existing knowledge e.g a phone was combined with a laptops features to form a smart phone.

Question 23

define incremental innovation? - give example

Answer 23

Steady stream of improvements that dont change the character of the product or process in a fundamental way. E.g the personal computer has seen constant improvements in processor speed and memory capacity. Adopts the specialisation view that with division of labour, increase expertise = increase efficiency,

Question 24

define architectural innovation

Answer 24

changes in the way that components are pieced together to make a system (partly incremental as doesnt undermine firms knowledge of components but partly radical as does undermine firms knowledge of product architecture.

Question 25

what is product innovations success measured by?

Answer 25

number of items sold
change in market power e.g Dysons bagless hoovers saw market power rise from 0 to 46% in 15 years.

Question 26

Define WTP and what factors affect it?

Answer 26

Price where the consumer is indifferent between having or not having the product.
Impacted by tastes and preferences, income, price and availability of complements and substitutes.

Question 27

Explain the shape of the WTP curve.

Answer 27

Shows consumer preferences in relation to price and quality - how much are consumers willing to pay for higher quality.
Intercepts the X axis which measures quality so there is a minimum level of quality the consumer requires to buy the product. It is convex but diminishing as consumers become satiated at certain levels of quality.

Question 28

Use a WTP curve to explain product choice?

Answer 28

Product must be on WTP curve to purchase (highest quality they can afford), best value for goods are situated below the WTP curve.

Question 29

What is a convex envelope curve?

Answer 29

Connects all points representing different points together, and identifies the boundaries in the product territory map.

Question 30

What is a territory map?

Answer 30

shows the slope of each part of the envelope curve and which product will be chosen based on one characteristic of multiple goods. It identifies the market share based on the slope of the WTP.

Question 31

Explain what product is chosen at which point on product territory map?

Answer 31

Initially product A (inferior) is chosen as the curve is flat (so not willing to pay more for higher quality). Then indifferent between product A at low price and B at intermediate price until beyond this point B is preferred to A. Then indifferent between intermediate price of B and higher price of C until curve becomes vertical and C is preferred.

Question 32

What determines an uncompetitive good and its degree? How can it become competitive?

Answer 32

If a product lies above the WTP it is overpriced and will never be purchased as consumers would purchase good on frontier. Level of uncompetitiveness is determined by height of vertical distance from the fronteir. This can be solved by lowering the price to the frontier - at this point the consumer would be indifferent to any other product on the same slope of the WTP envelope curve as the slope determines the WTP.

Question 33

How to show a) product innovation and b) process innovation on a product territory map?

Answer 33

Product innovation would shift the product to the right as can offer better quality at the same price
Process innovation would shift product lower as causes cost saving production process meaning they can produce same quality at a lower price (this would cut into the market share of inferior product)

Question 34

How does product and process innovation of intermediary product B affect market share of A and C? Show this on a product territory map.

Answer 34

Process innovation takes market share from A and C whereas product innovation mainly takes market share from A

Question 35

What is unitary organisational structure and its strengths and weaknesses?

Answer 35

Organisation is divided into functions
Pros-
. allows for division of labour (operational efficiency, producing at lowest costs) - best for large orgs
. DoL = suited to incremental innovation
Cons-
. not suited to radical innovation where many non routine decisions and doesnt promote information sharing
. tough to scale up by enetering new geo markets

Question 36

What is multidivisional structure and stregnths and weaknesses?

Answer 36

Organisation is divided into product lines and geogrpahic locations
Pros-
- copes better with redefining routines
- works best with network structures
Cons-
- not suited to deal with radical innovation as involves combination and bisociation which involves communication with unfamiliar communities.

Question 37

What is a network structure and its strengths and weaknesses with dealing with innovation?

Answer 37

more than one organisation combined together to produce goods, may outsource core functions. Workers are reconfigured as tasks change and relationships change based on task requirements.
Pros-
- structure is flexible so can deal with radical innovation
- can focus on core competencies in house
Cons-
- divided loyalties and issues with authority
- unstable job descriptions means specialisation hard / less EOS

Question 38

What type of business deals best with radical innovation?

Answer 38

Start ups because they can bring together new competencies without challenging existing structures and network structures as can reconfigure as tasks evlove, companies with flexible job descriptions.

Question 39

What type of hierarchial structure deals best with incremental innovation?

Answer 39

Complex hierarchies that divide into divisions which promote efficiency e.g M form and Matrix (as can report to more than one manager).

Question 40

There are two types of vision;
1. Bold statement that a technology has no future
2. publicise future plans
What are the benefits of each of these?

Answer 40

1. If have an existing market share, this prevents development of new techs
2. strong influence over customers as wait to buy new generation e.g apple phones.
   But this can be anticompetitive if not realistic and provides competitors with info.

Question 41

What is a tactical vision?

Answer 41

Where want to launch product in near future
solves faction differences or lose credibility
deters entry (e.g auction of computer chips)

Question 42

What is a strategic vision?

Answer 42

long term plan for product line
vision is known in advance so makes innovation seem more incremental
used to influence investment decisions (base on the long term - important if high switching costs)
and deter rivals