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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) 548