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current econ issues > week 7: innovation, R+D + 2 sided markets > Flashcards

week 7: innovation, R+D + 2 sided markets Flashcards

1
Q

research + development includes: [3]

A

(1) basic research
(2) applied research
(3) development

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2
Q

What is basic research?

A

☆basic research: work done to acquire new knowledge without any particular application or use in view☆

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3
Q

What is applied research?

A

☆ applied research: application of existing knowledge to problems involved in creating new products or processes - research that seeks a new or improved function, performance, reliability or quality ☆

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4
Q

What is “development”?

A

☆ development: systematic work on applied research ☆

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5
Q

Define innovation

A

☆ Innovation is an application of new ideas to the products, processes or other aspects of a firm that lead to increased “value”; it’s not an imitation or an adoption but a novelty — it’s a complex phenomenon ☆

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6
Q

What does innovation create?

A

1☆ new knowledge (invention/discovery)

2☆ widespread adoption (diffusion of new knowledge)

3☆ realisation of benefits to society

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7
Q

there are 2 types of innovation, they are?

A

[1] product innovation: introduction of a new product or significant qualitative change of existing product

[2] process innovation: introduction of a new process for making or delivering goods + services

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8
Q

Define R+D spending

A

The monetary value of resources a company spent on R+D

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9
Q

Define R+D Intensity

A

A share of the expenditures on R+D in the total revenue of a company

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10
Q

Another definition of R+D intensity?

A

a share of the aggregated expenditure on R+D in the GDP of a country

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11
Q

Examples of R+D spending?

A

Most R+D spending is done by the hardware producing industry in 2022, with 22,9%

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12
Q

5 Problems with innovation that could lead to market failure?

A
  1. Knowledge is a public good
  2. Spillover effect
  3. Indivisibility, uncertainty and capital
  4. Patent race and duplication
  5. Monopolistic power
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13
Q

how can “Knowledge being a public good” cause market failure?

A

New knowledge is both non-rival + non-excludable

☆ Production of new knowledge incurs large sunk costs BUT its MC is almost nothing.

Thus private provision of knowledge is suboptimal

^^ (new knowledge is freely available to everyone and sharing it is cheap, private companies might not have enough incentive to invest in creating it. This can lead to a situation where society doesn’t invest enough in developing new knowledge, even though it would benefit everyone)

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14
Q

How is spillover effect a problem with innovation and how might it cause market failure?

A

Innovations by 1 firm delivers a spillover effect (positive externality in production) on other firms.

☆ The social benefits of innovation exceed the private benefits of the innovating firm: thus innovations are undersupplied ☆

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15
Q

Explain how indivisibility, uncertainty and capital is a problem that can create market failure

A

☆ R+D spending is a large sunk cost - this cost is very indivisible. (cost cannot be spread out or divided over other areas; it’s a significant, one-time expense)

☆ R+D investment is very risky and return is uncertain

☆ Small firms need to **borrow capital ** to finance their R+D.

Given the risks of failure and large R+D costs, small private firms cannot obtain enough capital.

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16
Q

Explain how patent race and duplication is a problem w innovation that can create market failure

A

When many firms competing in R&D pursue the same goal, they might eventually obtain similar results

Rent-seeking behaviour gets firms involved in a patent race.

☆ If their results duplicate each other, R&D spending is socially wasteful! ☆

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17
Q

what is rent-seeking behaviour?

A

Rent-seeking behavior is when companies try to gain wealth or advantages by manipulating laws or regulations instead of through productive activities like innovation or creating new products.

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18
Q

Explain how monopoly power from innovation is a problem + creates market failure

A

Intellectual property rights on innovations (copyright + patents) provide and secure monopoly power.

All rights for any new product or technology are exclusive and belong to a patentee.

The market is monopolised and the outcome is inefficient

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19
Q

What is a solution for suboptimal provision of private knowledge?

A

Government supports scientific institutions and research centres and subsidises private research.

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20
Q

What is a solution for the spillover effect? (i.e internalise the externality)

A

☆ Collaboration ☆

Firms can internalise spillovers and avoid duplication of results by collaborating and running Research Joint Ventures (RJV)

Collaborating firms combine their resources and share risks

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21
Q

What is a solution for indivisibility, uncertainty and capital?

A

☆ Protection of Intellectual Property Rights ☆

A private firm has incentives to innovate only if it obtains exclusive rights for
its potential innovation. If IPR are not protected properly and anyone can use or copy innovations for free, private firms have no incentives to invest in R&D.

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22
Q

What is a solution for patent race and duplication?

A

☆ anti-trust regulation ☆

Antitrust regulation is a set of laws designed to prevent businesses from becoming too powerful, ensuring they compete fairly. This helps keep prices fair, improves choices for consumers, and encourages innovation.

IPR (intellectual property rights) allow a patentee to become a dominant firm or to capture the entire market.

Market power leads to higher prices, suboptimal production, and lower social welfare.

**Government should regulate the market and intervene if needed. **

Additionally, co-operation and RJV may facilitate a tacit collusion between collaborating firms.

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23
Q

What is a solution for monopolistic power?

A

☆ License Market ☆

Exclusive rights of a patentee prevent any sequential or complementary innovations (for 20 years).

Sometimes, a patentee may find it profitable to sell licenses, allowing others to use the innovation. Cross-licensing and pooled patents also facilitate technological progress.

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24
Q

the relationship between innovations and market structures is…?

A

complex, non-monotonic and bilateral

25
Q

4 relations between innovation + market structure

A
  1. R&D intensities differ across industries and market structures.
  2. The effect of market concentration and competition on R&D is non-linear (∩-shaped).
  3. The relationship is two-way: The established market structure affects firms’ incentives to innovate; however, innovations can also change market structures.
  4. The expected return on R&D is determined by the potential gain from innovation and opportunities to innovate:
  • Gains: larger market share, greater profits, etc.
  • Opportunities: the likelihood of success, facilities, innovation potential, available expertise, and financial capital.
26
Q

What are the incentives to innovate in a monopoly?

A

Modest incentives

  1. Potential gains are small relative to the monopolistic profits the firm earns.
  2. Both technological and product innovations lead to a modest increase in profits.
  3. Opportunities are good. A monopoly can finance expensive R+D projects and bear risks.

BUT the overall incentive is low because the firm has nobody to compete with regarding innovations (market alr captured)

27
Q

What are the incentives to innovate in a highly competitive industry?

A

WEAK INCENTIVES TO INNOVATE!

  1. Potential gains are large. A competitive firm can either:

a) raise its profits from 0 to the monopoly level (as IPR eliminate competitors)
or
b) become a dominant firm.

  1. The opportunities approach 0, as a small firm cannot finance expensive R&D projects and attract high-risk investment.
  2. With many firms in the market, the likelihood of duplicating results is high.
  3. The risk of irrecoverable costs is also high. Capacities and resources are limited.
    Thus, the expected benefit is rather low
28
Q

What are the incentives to innovate in a concentrated industry?

A

STRONG INCENTIVES TO INNOVATE!

  1. Potential gains are significant.
    A successful firm can become a monopoly or a dominant firm.

If the innovation lowers production costs, its profits will also grow because of cost advantage.

  1. The opportunities are favourable. In concentrated industries, firms are large enough to finance R&D projects, attract capital, and bear risks.
  2. In oligopolies, it is easier to negotiate and collaborate: firms can combine their resources, mitigate spillovers, and reduce the likelihood of duplication
29
Q

Network externality vs Network effect?

A

Network externality: More users make a product more valuable to each user (e.g., social media).

Network effects: The overall value of a product increases as more people use it.

30
Q

In some markets, a decision to buy a good depends on the number of users or consumers:

2 effects that cause this?

A
  1. Bandwagon effect - if the value of a good is increase with the no. of users, every addition purchases delivers a positive externality in consumption (herd behaviour, trends)
  2. Snob effect - if the value of a good is decreasing with the number of users, every additional purchase delivers a negative externality in consumption (congestion, exclusivity, uniqueness)
31
Q

2 Types of network effects?

A
  1. Same-side/direct effect
  2. Cross-side/indirect effect
32
Q

What is the direct network effect?

A

A given user’s utility increases with the number of other users

33
Q

What is the indirect network effect?

A

If there are atleast 2 independent groups of particpants, the utility of one group increases with the size of the other group

34
Q

Types of digital markets [5]

A
  1. Marketplaces: combine buyers + sellers, exhibiting strong indirect network effects
  2. Communication networks: combine users – exhibit strong direct effects
  3. Platforms: combine software developers and users – exhibit strong direct and indirect effects
  4. Data networks: collect data from users. Richer data improves the value of the service
  5. Social media: combines users and advertisers
35
Q

Diagram of network effects

A
36
Q

The demand for a network good is…

A

a function:

  • of price (P)
  • size of the network (Q)

– Demand is decreasing in price
– But, an increase in Q (Size of network) shifts the demand curve upwards

37
Q

What is critical mass?

A

The size of a network at which the value obtained from the good is equal to or greater than its price

38
Q

If Q < Critical mass,

The actual demand curve is..

A

Upward sloping!

39
Q

At the critical mass,

The value of the network good reaches…

A

Its maximum

40
Q

If Q > Critical mass,

The actual demand curve is…

A

Downwards sloping

41
Q

Draw the demand for network good diagram

A
42
Q

How do you **effectively ** use the network effect?

A
  1. Be the first in capturing a critical mass
  2. Pricing strategies
  3. Lock-in and switching cots
  4. Costly multi-homing
  5. Maintain capacity to avoid congestion

6 .Avoid network pollution

43
Q

How does being the first in capturing a critical mass ensure effective use of the network effect?

A

Businesses aim to be the first in their market and attract a large group of initial users, called a critical mass.

They may offer free subscriptions or perks to early users and encourage them to invite others.

Once a critical mass is reached, the network becomes more attractive to new users, who join on their own.

44
Q

What are some pricing strategies to use the network effect?

A
  1. FREEMIUM offer free basic services for all and monetise through premium features.
  2. DYNAMIC PRICING subsidised pricing or free access at the beginning to capture
  3. PRICE DISCRIMINATION offer different prices to users with different willingness to pay.
45
Q

What are lock-in and switching costs?

A

If users are locked in and have high switching costs, they cannot easily switch to another network.

Switching costs may be monetary, psychological, legal, etc.

46
Q

What is costly multihoming?

A

Incompatibility prevents adopting more than one competing networks.

This amplifies product differentiation and increases switching costs.

47
Q

What does maintaining capacity to avoid congestion mean?

A

If the network has a capacity constraint or a satiation point, an increase in the network size leads to depreciation.

Users will leave if the value of the network depreciates.

48
Q

How does avoiding network pollution efficiently use network effect?

A

You must keep the service relevant at scale.
The quality of the user-generated content should be high.

Spambots, internet bullying and trolling undermine the value of the network.

49
Q

How can the network effect be a source of market power?

A
  1. If the network effect is strong, consumers tend to coordinate their adoption of a single network good.
  2. The network effect reduces the available residual demand for new entrants and raises entry barriers.
  3. New firms fail to reach a critical mass if established firms have large networks.
  4. High switching costs and costly multihoming intensify consumer loyalty.
  5. Network goods are usually provided by oligopolies or by markets with one dominating firm.
50
Q

What is a Two-Sided Market?

A

Two-sided markets involve two or more groups of participants interacting via platforms and have at least one group exposed to a network effect.

51
Q

Example of two-sided markets?

A

☆ Sellers → Marketplace ← Buyers

☆ Payer → Payment System ← Payee

☆ SW Developers – Operation System – Users

☆ Retailers – Shopping Centre – Customers

☆ Users – Social Media – Advertisers

☆ Riders – Rideshare App – Clients

☆ Airlines – Airports –Travelers

☆ Job seekers – Job Search Sites – Employers

52
Q

Diagram of two-sided markets

A
53
Q

Take for example: VIDEO GAME CONSOLE MARKET

The market of video game consoles is a two-sided market, where console producers combine two sides – players and game developers

What is the same-side network effect vs Cross-Side network effect?

A

Same-side network effect:
* The larger the number of a given console’s players, the greater the value of the console’s network.

Cross-side network effects:
* The larger the console’s clientele, the more developers produce video games for the console.
* The more games are developed for a given console, the more players want to buy that console.

54
Q

What are multi-sided markets?

A

In some markets, there are more than two sides. For example, Uber Eats combines restaurants, riders, and clients. Rightmove combines tenants, landlords, buyers, sellers, and estate agencies.

55
Q

What does pricing platforms and complements mean?

A

Sometimes platforms also compete with the final good sellers. For example, Microsoft produces software programmes and video games. In this case, it becomes a multiproduct firm producing complements. The pricing strategies of such firms differ from the standard model.

56
Q

What does exclusivity and compatibility do?

A

Incompatibility of platforms or final goods raises switching costs and locks in consumers. In some cases, firms may choose to expand their clientele by making their products compatible.

57
Q

What are intermediaries?

A

In some markets (TV ads, VG consoles), platforms do not directly interact with final users or sellers but through exclusive dealers or distributors. The market structure becomes more complex. Intermediaries are usually monopolies or oligopolies.

58
Q

What is anti-trust regulation?

A

Antitrust regulation prevents unfair business practices and promotes competition in markets.

Given high market concentration and power in markets with network effects, the resulting outcome is not efficient.

– The government should intervene and regulate the conduct of firms.

59
Q

What is a network good?

A

A good whose value to one consumer increases the more that other consumers use the good

current econ issues (8 decks)

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