1. Economics 124/PP 190-5/290-5 Innovation and Technical Change Diffusion of innovations Prof. Bronwyn H. Hall

2. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-52 Outline – Diffusion (Oct. 26,28)  Introduction  Economic determinants of diffusion  Overview of some models  Factors affecting the pace of diffusion  Example: the dynamo and the computer

3. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-53 Diffusion  Dictionary definition: The spread of linguistic or cultural practices or innovations within a community or from one community to another  Course definition: The spread of an innovation throughout the economy or the relevant set of potential users – examples: Almost all consumers – TV, indoor plumbing ATM machines – banks and retail stores  Sometimes referred to as “adoption” When looked at from the point of view of individual choice by consumers or firms

4. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-54 The historical view “in the history of diffusion of many innovations, one cannot help being struck by two characteristics of the diffusion process: its apparent overall slowness on the one hand, and the wide variations in the rates of acceptance of different inventions, on the other.” (Rosenberg, 1976, p. 191).

5. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-55 The s-curve for diffusion  Shows how the number of users of a new technology grows over time (usually measured as a share of potential users). Begins trending upward very slowly At some point becomes much steeper (as the technology spreads rapidly) Eventually flattens out because there are fewer and fewer potential users that have not already adopted  Graph shows the diffusion of some major consumer inventions in the United States during the past 100 years.

6. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-56 U.S. diffusion of major inventions

7. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-57 Bottom-up view Adoption from the point of view of adopter:  Investment under uncertainty  Once done, costs are sunk  Like an option Adoption from the point of view of the innovator or supplier:  Marketing goal – reaching a new customer  Focus on network effects, either technological or social

8. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-58 Top-down view  Channel from innovation to economic growth mediated by diffusion, which can be surprisingly slow need to understand process to understand why  Some examples Diffusion of electricity required complete factory redesign; infrastructure Diffusion of computing technology and internet  Productivity growth sometimes surges 20-30 years after initial introduction of new general purpose technology (GPT)

9. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-59 Economic determinants The adoption decision will depend on the factors that usually affect investment decisions: Benefits Costs Risk and uncertainty/information Environment and institutions – market and/or regulatory

10. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-510 Benefits depend on  Closeness of substitute technologies Radio versus automatic clotheswasher Mobile and landline telephones  Networks and standards (more later) ATM adoption by banks VHS/Beta Wireless computing and 802.11b  Experience and Learning Investment in adopter skills

11. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-511 Costs depend on  Price of new technology  Complementary investments Infrastructure and other capital equipment Training/skills  Scale Due to fixed cost nature of adoption in many cases Mechanical reaper in 19C (David on UK)  Cost of finance Large body of literature on innovation investment where there is uncertainty

12. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-512 Uncertainty/information  New technology – less understood, more uncertainty about how well it works  Uncertainty about whether it will be successful (standards)  Benefits are a flow, costs are upfront => benefits may be more uncertain  The option to delay decision in order to acquire more information may cause delay in adoption Luque (2002) – new manufacturing technology adopted more quickly in industries with lower sunk costs, lower uncertainty

13. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-513 Environment – market structure Size and/or market power of adopters:  Accelerates diffusion Scale economies  Delays diffusion Slower and less flexible Size and/or market power of suppliers:  Accelerates diffusion Sponsoring a standard (e.g., IBM and the personal computer) – mobile telephone evidence  Delays diffusion Higher prices Less fear of market share loss to entry (see ATT in 1960s)

14. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-514 Environment - regulatory  Accelerates adoption mandates pollution or safety standards solves coordination problems in network industries  Delays adoption Safety regulation, e.g., new pharmaceuticals and medical instruments, PVC pipe Standard-setting process - telecommunications (ATT again) New California law and lighting innovation?

15. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-515 Some empirical examples

16. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-516 Models – the s-curve  Heterogeneous adopters Benefits have a unimodal distribution Costs decline monotonically Adopt when benefit>cost  Epidemics (spread of information) Small share adopt They encounter the remainder randomly; those contacted adopt Implies 3-parameter logistic Both models => s-shaped curve for diffusion

17. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-517 Models - sunk costs  Adoption is investment under uncertainty Compare an upfront cost with a stream of future benefits =>adoption an absorbing state in the sense that once costs incurred, they are sunk  Decision is Not “adopt or do not adopt” But instead “adopt now or wait to decide later”  Real options models (Stoneman 2001) Uncertain payoff is modelled as a stochastic process If it reaches a high enough value (strike price), the option to invest is exercised.

18. Fall 2004 (C) B H HallEcon 124/PP 190-5/290-518 Internet diffusion in Econ 124  Computer ownership: 1997, 80% of class 2003, 100% of class  Internet use 1997 to 2003 Total use increased Recreational use relatively more important in 2003 More classwork done at home Web surfing increased more than email  University service improved a lot => WTP (Willingness To Pay) decreased

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