Economic growth and economic development 559

Introduction to Modern Economic Growth
in costs, but air-conditioners became much more energy-efficient, which, they argue,
was a response to higher energy prices. This seems to be a clear example of the
pace and the type of innovation responding to profit incentives. In a related study,
Popp (2002) finds a strong positive correlation between patents for energy-saving
technologies and energy prices and thus confirms the overall picture resulting from
the Newell, Jaffee and Stavins study.
Evidence from the pharmaceutical industry also illustrates the importance of
profit incentives and especially of the market size on the rate of innovation. Finkelstein (2003) exploits three different policy changes affecting the profitability of developing new vaccines against 6 infectious diseases: the 1991 Center for Disease Control
recommendation that all infants be vaccinated against hepatitis B, the 1993 decision
of Medicare to cover the costs of influenza vaccinations, and the 1986 introduction
of funds to insure vaccine manufactures against product liability lawsuits for certain
kinds of vaccines. She finds that increases in vaccine profitability resulting from
these policy changes are associated with a significant increase in the number of clinical trials to develop new vaccines against the relevant diseases. Acemoglu and Linn
(2004) look at demographic-driven exogenous changes in the market size for drugs
of different types and find a significant response in the rate of innovation to these
changes in market sizes.
To sum up, the evidence suggests that profit motives and the market size are
important determinants of innovation incentives and the amount and type of technological change. This evidence motivates the types of models we will study, which
make technological change an economic activity, responding to economic incentives.
12.3. The Value of Innovation in Partial Equilibrium
Let us now turn to the analysis of the value of innovation and R&D to a firm.
The equilibrium value of innovation and the difference between this private value
and the social value (i.e., the value to a social planner internalizing externalities) will
play a central role in our analysis below. All of the growth models we have studied
so far, as well as most of those we will study next, are dynamic general equilibrium
models. In fact, as emphasized at the beginning, economic growth is a process we
can only understand in the context of general equilibrium analysis. Nevertheless, it
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