Economic growth and economic development 562

Introduction to Modern Economic Growth
The first term in the second line is the increase in consumer surplus because of the
expansion of output as the price falls from ψ to λ−1 ψ (recall that price is equal to
marginal cost in this social planner’s allocation). The second term is the savings
in costs for already produced units; in particular, there is a saving of ψλ/ (λ − 1)

on D (ψ) units. Finally, the last term is the cost of innovation. Depending on the

shape of the function D (p), the values of λ and µ, this social value of innovation
can be quite large.

12.3.2. Some Caveats. The above example illustrates the problem of innovation under pure competition in a very sharp way. The main problem is the inability
of the innovator to exclude others from using this innovation. One way of ensuring
such excludability is via the protection of intellectual property rights, or a patent
system, which will create ex post monopoly power for the innovator. This type of
intellectual property right protection is present in most countries and will play an
important role in many of the models we study below.
Before embarking on an analysis of the implications of ex post monopoly power of
innovators, there are a number of caveats we should emphasize. First, even without
patents, “trade secrecy” may be sufficient to provide some incentives for innovation.
Second, firms may engage in innovations that are only appropriate for their own
firm, making their innovations de facto excludable. For example, imagine that at
the same cost, the firm can develop a new technology that reduces the marginal
cost of production by only λ0 < λ, but this technology is specific to the needs and
competencies of the current firm and cannot be used by any other. We will show that
the adoption of this technology may be profitable for the firm, since the specificity
of the innovation firm acts exactly like patent protection (see next subsection and
also Exercise 12.5). Therefore, some types of innovations can be undertaken under
pure competition.
Finally, a number of authors have recently argued that competitive innovations
are possible, when firms are able to replicate the technology and sell it to competitors

during a certain interval of time before being imitated by others (e.g., Boldrin and
Levine, 2003).
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