Economics (9640) | Technological change

📝 Technological Change: The Engine of Costs, Revenue, and Profit

Welcome to the chapter on Technological Change! This topic is absolutely central to economics because technology doesn't just make our lives easier; it fundamentally changes how firms produce goods, how much it costs them, and what new opportunities (and threats!) they face in the market.

In this unit, we see how a new invention can dramatically shift a firm's cost curves downwards, potentially leading to huge profits and disrupting entire industries. Ready to explore how innovation drives the economy? Let's dive in!

1. Invention vs. Innovation: The Critical Difference

Before we look at the effects, we must clearly define what we mean by "technological change." Economists distinguish between two key concepts: Invention and Innovation.

A. Invention

Invention is the creation of a new idea, process, or product.
It's the 'eureka' moment in the lab.

• It is purely theoretical or scientific discovery.
• Example: The physicist who first develops the theory of how a laser works.

B. Innovation

Innovation is the successful commercial application of that invention.
It's taking the idea and turning it into a marketable reality.

• This is what truly creates economic change.
• Example: A firm using laser technology in medical surgery or manufacturing cars.

Quick Tip: Think of it this way: Invention is the Idea. Innovation is the Implementation.

Key Takeaway: For economics, innovation is what matters most because it affects actual production, costs, and market outcomes.

2. Impact on Production Methods, Productivity, and Costs

Technological change directly targets a firm's efficiency, dramatically affecting the production process and, crucially, the firm's costs.

A. Better Methods of Production

New technology often involves acquiring new or improved capital (like advanced machinery or software). This allows firms to adopt radically different, more efficient ways of manufacturing or delivering a service.

• Example: A car factory replacing human welders with high-speed robotic arms.

B. Increased Productivity and Efficiency

One of the most immediate effects of new technology is boosting Productivity.

Productivity measures output per unit of input (e.g., output per worker, known as Labour Productivity).

• If a machine (technology) allows one worker to produce 100 items an hour instead of 50, labour productivity has doubled.
• Efficiency improves: firms can produce the same output with fewer resources, or more output with the same resources.

C. The Effect on Firm’s Costs of Production

When productivity increases, the cost of producing each individual unit falls. This is the main link between technology and costs.

• As output per input rises, the Average Cost (AC) and Marginal Cost (MC) curves of the firm will shift downwards.
• Analogy: Imagine printing flyers. A slow, old printer has high costs per flyer. A new, industrial printer (technology) is much faster and uses less ink per page, dramatically lowering your average costs.

Don't Forget: Lower production costs translate directly into higher potential profits (if revenue remains constant) or allow the firm to lower prices and gain market share.

3. The Transformative Effect on Markets

Technological change doesn't just affect internal production; it can reshape the entire economic landscape by creating and destroying markets.

A. Development of New Products and Markets

Innovation creates goods and services that consumers didn't even know they needed, opening up vast new markets, potentially globally.

• Example: The invention of the microchip led to the innovation of personal computers, creating the massive global computing market. The mobile phone was a new product that created the app market.

B. Creative Destruction

This is a famous concept introduced by economist Joseph Schumpeter. It describes the "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating the new one."

• Technological change destroys existing markets (the "destruction" part) because superior, innovative products replace outdated ones.
• Example: Digital cameras (new technology) destroyed the market for film roll manufacturers (Kodak) and traditional photo development shops (old markets).

Did you know? Schumpeter argued that creative destruction is the *essential fact about capitalism*. Without it, economies stagnate.

C. Influence on Market Structure

Technology can influence how competitive a market is.

• Increased Economies of Scale: Complex, expensive technology often requires huge investment (high fixed costs). This drives firms to produce massive outputs to achieve low average costs (Economies of Scale).
• Result: The market may become dominated by a few large firms (Oligopoly or Monopoly), as smaller firms cannot afford the necessary initial investment (this acts as a barrier to entry).
• Example: The extreme costs of building chip fabrication plants (fabs) mean the semiconductor industry is dominated by a few giants like TSMC and Samsung.

Key Takeaway: Technology is a powerful force that leads to dynamism but can also lead to market concentration.

4. Intellectual Property Rights (IPR) and Patents

Innovation is incredibly costly and risky. Firms spend huge sums on Research and Development (R&D). If a competitor could simply copy the final product for free, the original innovating firm would lose all incentive to invest. This is why we need protection.

A. Patents and IPR

Patents are a form of Intellectual Property Right (IPR) granted by the government to an inventor, allowing them exclusive rights to manufacture, use, or sell their invention for a fixed period (usually 15–20 years).

The goal is to provide a temporary monopoly position to the innovator.

B. Arguments For Protecting IPR (Patents)

• Incentive to Innovate: Firms know they can recoup massive R&D costs and earn Abnormal Profit while the patent lasts.
• Increased Dynamic Efficiency: By promoting R&D and future innovation, patents improve the long-term health and efficiency of the economy.

C. Arguments Against Protecting IPR (Patents)

• Temporary Monopoly Power: The patent owner gains temporary monopoly power, which often leads to higher prices and lower output than in a competitive market (potentially resulting in Allocative Inefficiency in the short run).
• Stifled Competition: New firms cannot enter the market with the best technology until the patent expires, slowing down the diffusion of knowledge.

Key Takeaway: Patents involve a trade-off: short-run inefficiency (high prices due to monopoly) for long-run dynamic efficiency (more innovation).

5. The Role of Government in Technological Change

Governments play a crucial dual role in technological change: generating it and regulating it.

A. Generating Technological Change

Technology can be generated in both the public and private sectors. Because R&D often benefits society far more than it benefits the individual firm (a form of positive externality), the private sector may under-provide R&D.

• Direct Funding: Government spending on basic research, universities, and public labs (e.g., funding medical research).
• Infrastructure Investment: Investing in high-speed fibre optic cables or reliable energy grids makes it easier and cheaper for private firms to use and innovate with technology.

B. Influencing Technological Change (Regulation and Incentives)

Governments influence private R&D through fiscal policy and regulation:

• R&D Tax Credits: Reducing taxes for firms that invest heavily in research and development, acting as a direct incentive.
• Granting Patents: Implementing and enforcing the system of patents and IPR (as discussed above).
• Competition Policy: Ensuring that dominant firms do not use their technological advantage to crush all competition unfairly, maintaining a market structure that encourages new innovators.

Key Takeaway: Governments ensure the legal framework (patents) exists and often bridge the gap where private firms won't invest due to risk (basic research funding).