The Economics of Information

Schumpeter’s early classic, The Theory of Economic Development (1911), broke with the traditional static analysis of its, time by emphasizing the importance of the entrepreneur or innovator. the person who introduces  “new combinations” in: the form of new products or methods of organization. Innovations result in temporary super normal innovation profits. which are eventually eroded away by imitators. Ever the romantic. Schumpeter saw in the entrepreneur the hero of capitalism. the person of “superior qualities of intellect and will.” motivated by the “ill to conquer and the joy of creation. This vision of capitalism as a dynamic process has inspired a new generation of growth theorists. such as Stanford’s .Paul Rome, who have developed a Schumpeter theory of induced innovation to the more traditional neoclassical growth theory.

Modern interpretations of the Schumpeter vision emphasize the special economic problems involved in the economics of information. Information is a fundamentally different commodity from normal goods. Because information 10 product bill cheap to reproduce. markets in information are subject to failures. Consider the production of a software such as Windows 98. This program took several years and cost Microsoft over Sl billion to develop. Yet you call purchase a for about $150 or use your copy for free (hut take heed about COP) light laws). The same phenomenon is at work in publishing, pharmaceuticals, entertainment , and other areas where goods have high information content. In each of these areas, the actual conception and development of the product may be a laborious process that takes years or even a lifetime.

But once the work is recorded on paper, in a computer, on a tape or compact disc, it can be reproduced and used by a second person essentially for free. The inability of firms’ to capture the full monetary value of their inventions is called inappropriateness. Case studies by Edwin Mansfield and others have found that the social return to invention (that is, the value of inventions to all consumers and producers) is many times the appropriate private return to the inventor (that is, the monetary value of the invention to the inventor). Information is expensive to produce but cheap to reproduce. To the extent that the rewards to invention are in appropriate, we would expect private research and .development to be underfunded. with the most significant under investment in basic research, The in appropriabiliry and high social returns on research lead most governments to subsidize basic research in health and science and to promise special incentives for creative activities.

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