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Economics of Innovation

Welfare gains from product innovation

Manuel Trajtenberg2005

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Reminder: social benefits from Reminder: social benefits from processprocess innovation innovation

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Griliches: social returns from hybrid corn – 700%

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But what if product differentiation, choose just one?

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The frameworkThe “magnitude” of product innovation between two periods: the increment in consumer surplus associated with having the latest choice set (St) rather the previous one (St-1) :

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The MNL and the surplus function

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Estimation - Endogeneity

Estimate MNL for differentiated products in the market. Issues: IIA, and:

Serious problem: endogeneity of price, i.e. price (positively) correlated with unobserved quality (which goes into the error term), hence upward bias in estimation of – critical (see surplus function)!

In study of CT Scanners, finding of upward slopping demand curve, for that reason; correction using residuals from hedonic price function. But later on whole literature on how to cope with the problem – BLP etc.

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Key issue in Medicine: ability to visualize internal organs. X-rays (~1900), ultrasound (1950s), gamma camera (1960s). All of these: rather crude. Otherwise: cut open!

Hounsfield began work on CT at EMI, in 1967. First installation: 1973. First only head, then also body scanners.

Godfrey Hounsfield and Allan M. Cormack (Tufts University) got the Nobel Prize in Medicine in 1979.

Since then: MRI, fMRI, PET, angio CT, etc.

Computed Tomography (CT) Scanners

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First Generation CT Scanners

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Second Generation CT Scanners

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Third Generation CT Scanners

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Performance Characteristics of CT Scanners

CT Scanners: highly complex systems, yet main attributes:

• Scan time: how long it takes to scan one thin cross-sectional “slice” (minutes at first, down to 1 sec)

• Spatial Resolution – size of smallest object that can be just visualized in best of conditions (but there is more to image quality).

• Reconstruction time: from end of scan to image display.

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Diffusion of CT Scanners by Hospital Size

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CT Scanners: Market Indicators

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Firms in CT

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Prices and characteristics of CT Scanners

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CT Scanners: sales, firms, and R&D (R&D: for US firms only, in constant 1982 millions $)

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Reminder: the framework

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Estimating the Nested MNL

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Estimate two clusters, one for Head (H) the other for Body (B) scanners,

If = 1 then back to the MNL, if = 0 then separate “markets”.

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Estimates for Head Scanners

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How to compute W

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Given changes in tastes over time, two ways to compute the welfare gains from year to year:

“Dual inducement” mechanism, hence in practice found ex-ante > ex-post

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Annual incremental gains (W) to representative user

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How to compute “total gains” from product innovation?

One angle of the issue:

Consumer buying PC today: should we take into account only the latest innovations? Or should we say that he/she is benefiting from the long sequence of innovations since say the first computers (the ENIAC) on? Or perhaps just since the first Apple?

Another angle:

Should we just multiply Wt times to number of

buyers at t? Or perhaps times the number of projected buyers from t on?

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How to compute “total gains” – cont.

Estimate diffusion as a function of e.g. Wt that is,

innovation moves up the ceiling, bringing in new consumers. Assign to these additional consumers the benefits Wt . (but discount them back to t)

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Computing total gains

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Total Gains and R&D

Social rate of return: 270%