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What Are The Incentives To Innovate? Which Market Structure Creates The Best Conditions For Innovation?

982 words - 4 pages

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What are the incentives to innovate? Which market structure creates the best conditions for innovation?

Foreword

What is the key to the answer on topic questions? To my mind this is the potential of the company to receive profits and degree of competition on the market. In reality the research and development (R&D) activity is not cheap. Sure, there are a lot of examples when ordinary people made important inventions but they are exception to the rule.

If profits give the possibility for innovations, what are the incentives? As to me the best incentive is competition for profits in short and long run. In turn, competition is determined by various entrance barriers.

So let's consider different market structures to find the possibilities for profit and healthy competition.

Perfect competition

The characteristics of the perfect competition are a great number of buyers and sellers, ordinary goods, transparency of information about market, absence of entrance and exit barriers. In practice pure competition is rare because there are always some kind of barriers and biased information. Good example of pure competition approximation is e-commerce.

For the company operating in such environment, the demand is flat; the firm is price-taker. Low entrance barriers not always say that competition is severe. Companies sell standard products and there are a lot of buyers, the market is immense comparatively with the power of one single player.

The firm can maximize its profit only by putting MC (marginal cost) down and producing more goods. In theory this may represent a good stimulus for innovation of a new production method.

For instance, we have a farmer that cultivates wheat. How he can maximize his profit? He can not increase the price. Only by reducing his costs and enlarging his output.

Are there conditions to introduce new goods? To a one single farmer it is practically impossible to invent new kind of wheat. Are there the conditions to introduce new method of production? Maybe to some extent but new equipment cost a lot. The best condition for profit maximization is the crop failure. The market price will go up and the farmers will be more profitable.

And we also know in this market structure the profit of all producers tend to zero in long run due to low entrance barriers! This de-motivates innovation and even the production!

Monopoly

Monopoly is "price-maker" with high entrance barriers to the market. The lack of competition does not encourage innovations. But monopolies have abnormal profits and can invest these profits in new technologies to insure their dominant positions on the market, because there is a threat to...

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