Policy for innovation

Question 1

What is market failure?

Answer 1

failure to allocate resources efficiently in the free market. It is not pareto efficient and benchmarks of perfect competition are not acheived. Some socially desireable activities do not take place.

Question 2

What is the cobra effect and give an example?

Answer 2

Paradox of government intervention in terms of the law of unintended consequences. E.g in COVID oubs shut at 10pm to prevent contagion but this meant people continued to socialise after in more intimate settings of houses.
E.g sept 2022 mini budget; caused loss of gov credibility amongst foreign investors, it was designed to stimulate growth and combat fuel crisis but exaccerbated the problems it was trying to solve.

Question 3

Why are governments pro innovation?

Answer 3

Generates growth due to job creation, higher skills = better living standards.

Question 4

How does the gov try to foster innovation?

Answer 4

Via poliocies;
- increase annual public investment on R&D to £22bn
scale up visa routes to attract high skilled global workers

Question 5

List 3 sources of market failure?

Answer 5

• EOS
• Asymmetric information
• Externalities

Question 6

What is EOS?

Answer 6

Producing one more unit leads to lower unit costs of production.

Question 7

Why is EOS a source of market failure?

Answer 7

Where large fixed costs exist, it is not profitable to sell at MC. Price must be raised to recover costs and this prices consumers who were willing to pay price at MC out of the market.
Creates a move towards monopolisation as larger companies will always have lower avg unit costs than smaller organisations so can undercut small scale producers

Question 8

Use the diagram of incumbent firms vs new entrants unit costs to explain the monopolisation?

Answer 8

Incumbent firms with EOS can produce at MES of production Q* (lowest unit cost) whereas new entrants without EOS can only produce at QNew (significantly lower quantity at much higher cost)

Question 9

How can market failure through EOS be solved?

Answer 9

Recognise which industries have a natural monopoly and will benefit from EOS and regulate their prices or place in public sector so that there is no profit max objective.

Question 10

Define asymmetric information.

Answer 10

One party has more information than another party, normally the seller knows more than the buyer e.g in second hand car market when determining quality.

Question 11

Explain the lemons theory in terms of asymmetric information.

Answer 11

Buyer can’t determine which car is a good car and which is a lemon so take an avg price. So good and bad cars are sold at the same price. Good cars exit the market as avg price too low. Causes avg price to fall even more so avg cars exit the market so that only lemons are provided.

Question 12

Why is lemons theory an example of market failure?

Answer 12

The price mechanism fails to work - high priced car is not necessarily good quality, sellers of good cars cant charge premium prices for superior quality
Good cars aren’t provided by the market.

Question 13

How to solve asymmetric information?

Answer 13

Information provision (independant evaluation agencies)
guarantees
standards of certification

Question 14

Define;
a) positive externality
b) negative externality

Answer 14

a) markets make some activities look privately unprofitable but are socially desireable e.g Covid Vaccine, business profits soar and effect on aviation industry
b) markets make some activities look privately profitable but socially undesirable e.g carbon intensive economic activity or AI displacing jobs.

Question 15

Why do externalities cause market failure?

Answer 15

No one pays for all the benefits or costs, market generates too few activities with positive externalities and too many that generate negative externalities.

Question 16

What are the solutions to externalities causing market failure?

Answer 16

• defining property rights and charging beneficiaires royalties
• take away incentives by taxing those responsible for neg ex
• subsidise activities that generate pos ex
• provide socially desireable but privately unprofitable activities via the public sector.

Question 17

How might R&D for innovation result in market failure?

Answer 17

R&D can generate EOS as only ever beneficial when done on a large scale. It is predominantly a fixed cost and can be reproduced (photocopied) at a relatively low MC. Wide variety of information activities have a natural monopoly attatched to it. Greater demand for information spreads fixed costs, increasing returns to application.
Covering fixed costs of R&D in competitive market will result in having to monopoly price to cover costs.

Question 18

Evaluate R&D for innovation resulting in market failure?

Answer 18

Information transmission is not always acheive at 0 MC. Technology is not costlessly reproducible. It is locally specific.
Idea that R&D is production of information is misleading - it can be tacit rather than codified and not expresssed as simple bits of information.
Can add value by repackaging information

Question 19

How does R&D in innovation create positive externalities? How does this lead to market failure,

Answer 19

One firms R&D have benefits for other firms in related businesses and industries.
In this case, the innovator can not appropriate the full social benefits of its innovation (private costs of R&D < social costs). Combined social benefit (to innovator and other firms that benefit is greater than the cost) but the private benefits to the innovator do not outweigh the private costs so cut back on R&D.
Info can be easily diffused

Question 20

How can firms overcome market failure whereby R&D generates positive externalities?

Answer 20

Firms create joint ventures to internalise mutual externalities of their R&D programmes and develop property right schemes to improve appropability.

Question 21

What is the dilema in imposing property rights on R&D to solve msrket failure of positive externalities?

Answer 21

Why charge for something that has a MC of 0 to reproduce and fewer agents benefit from investment in information gathering.

Question 22

How can R&D generate negative externalities?

Answer 22

Innovations that reduce market share of others so private benefit of R&D exceeds the social benefit (benefits to consumer and other businesses). This is more common in oligopolistic markets where similar products are produced. More likely to overinvest in R&D when comp intense. Negative externalities and pos ex will be produced simultaneously but unlikely that they will offset eachother.

Question 23

Evaluate R&D creating negative externalities?

Answer 23

Duplication not wasteful if R&D is to assimilate existing tech knowledge. Instead may be essential for diffusion.

Question 24

Why is information like a stock that appreciates with use?

Answer 24

yields a service and becomes more valuable as increased quality of info improves when passed around a network where people can refine it and it can be used in the progression of technology. This creates mutual pos ex but market failure may exist if network is too small.

Question 25

What are the drawbacks of government policy to correct market failure?

Answer 25

Hard to find the optimum policy when there is more than one market imperfection that are interdependant
When evaluating activities they will not appear profitable as trying to make certain activities happen that

Question 26

What are three policies used to correct market failure?

Answer 26

Subsidising R&D activities that generate pos ex
Enforce property rights to ensure no free spillovers to third parties
Gov expenditure on activities that arent provided by the market

Question 27

What is the difference between general and specific subsidies?

Answer 27

General - tax breaks or R&D expenditure promote a range of activities
Specific - given in areas of economy that show potential or promote adoption of upcoming technology.

Question 28

Evaluate the use of subsidies?

Answer 28

Is it promoting additional R&D activity or is it just increased surplus for those firms that alreadly happily invest in R&D.

Question 29

Give examples of subsidies used in the UK?

Answer 29

• tax credits;
• direct grants to SME’s to carry out R&D on tech innnovative products and processes

Question 30

What is a property right for knowledge? How does it solve market failure.

Answer 30

IP internalises externalities that would be enjoyed by third parties,

Question 31

What are the disadvantages of putting property rights on knowledge?

Answer 31

Costly to administer and prevents diffusion of knowledge by putting a price tag on what was originally a free spillover.

Question 32

What is a drawback to direct public policy providing public goods?

Answer 32

Public agencies dont have commercial info and market incentives that firms in the industry would possess. So more appropriate with basic research.
Gov funded research could crowd out privately funded research if competiting for scarce knowledge or displace the private incentive to engage in research as offered freely.

Question 33

Why does knowledge create market failure?

Answer 33

It is a partial public good so non rivalrous and non excludable. This creates issues of free riding.

Question 34

Give examples of transaction costs?

Answer 34

Licensing contracts, and IP enforcement costs, contracts for buying and selling technology.

Question 35

Why does market failure exist in network markets?

Answer 35

Due to getting ‘locked in’ a standards race - end up choosing an inferior product for reasons other than technology.
Firms may provide lower compatability than socially optimal e.g range of USB connectors - dont all work.

Question 36

What is an Ex-ante intervention in the networks market? How might it be acheived.

Answer 36

government take an active role in the competition process. They might reduce comp initially as the whole industry converges to one standard.

Question 37

Give a way in which a standard might be acheived in a market:
a) De Facto
b) De Jure
Give a pro and con for each.

Answer 37

a) standards race
- quick to emerge
- inefficient as market may choose a privately profitable one but socially undesireable
b) pre market standardisation agreement
- slow to emerge
- legitimate, developed transparent agreed procedures and based on consensus of all interested parties.

Question 38

What is an ex post intervention?

Answer 38

Gov doesnt influence competition process but attempts to safeguard and control firm conduct.

Question 39

What is the new scrutiny bill for digital markets in the UK?

Answer 39

Bill provides three scrutinies exercised by the DMU aimed at tech companies that have substantial and entrenched market power or that might be expected to in the near future.
1. Set ex ante conduct requirements (rules for what firms can/not do
2. enforce ex post pro competition enforcement policies
3. require reporting of M&A activity before deals are completed.

Question 40

What are the drawbacks of ex post intervention?

Answer 40

Takes a backwards looking approach
Not that useful when firms have successive market power

Question 41

What are the drawbacks to ex ante intervention?

Answer 41

• can stifle innovation especially innovation that is socially desireable.
• not good for rapidly evolving markets
• should be used when cost of externalities is high e.g pre market authorisation for pharamceuticals.

Question 42

Benefits of ex post intervention?

Answer 42

Promotes innovation
Minimises regulatory burden
Promotes operational efficiency

Question 43

What policy is best suited in -
a) the short run
b) the long run

Answer 43

a) to induce competition in the short run cooperate standard setting should not be allowed
b) to have competition in the long run cooperative standard setting should be allowed as a standards war would induce a winner takes all situation.

Question 44

Give examples of government expenditure?

Answer 44

• direct spending on universities
• knowledge transfer institutions
• programmes to support specific technologies e.g automotive