Economic growth and economic development 578

Introduction to Modern Economic Growth is independent of the others Imagine that the individual invests an amount x/N in each of N projects The Strong Law of Large Numbers implies that as N → ∞, a fraction p of these projects will be successful and the remaining fraction − p will be unsuccessful Therefore, the individual will receive (almost surely) a utility of u (y + (p (1 + R) − 1) x) Since + R > 1/p, this is strictly increasing in x, and implies that the individual would prefer to invest all of its endowment in the risky projects, i.e., x = y Therefore, the ability to hold a balanced portfolio of projects with independently disputed returns allows the individual to diversify the risks and act in a risk-neutral manner A similar logic will apply in many of the models we will study in the next three chapters; even though individual firms will have stochastic returns, the representative household will hold a balanced portfolio of all the firms in the economy and thus will have risk-neutral preferences in the aggregate This will imply that the objective of each firm will be to maximize expected profits (without a risk premium) 12.6 Taking Stock This chapter has reviewed a number of conceptual and modeling issues related to the economics of research and development We have introduced the distinction between process and product innovations, macro and micro innovations, and also discussed the concept of innovation possibilities frontier and the importance of the non—rivalry of ideas We have also seen why ex post monopoly power is important to create incentives for research spending, how incentives to undertake innovations differ between competitive firms and monopolies, and how these compare to the social value of innovation In this context, we have emphasized the importance of the appropriability effect, which implies that private value of innovation often falls short of the social value of innovation, because even with ex post monopoly power an innovating firm will not be able to appropriate the entire consumer surplus created by a better product or a cheaper process We have also encountered the famous replacement effect, which implies that unless they have a cost advantage, incumbent monopolists will have weaker incentives to undertake research to improve their products than 564