Economics of Innovation

Economics of Innovation

In this article, you will learn the economics of Innovation. More precisely, what is the impact of product innovation and process innovation on the demand curve?

I read this interesting explanation of the economics of innovation when I was teaching a course on innovation management. It was an interesting explanation of how innovation changes the demand and supply curve for a company or industry. The authors explained this concept very easily and impressively.

Let us see how product innovation and process innovation impact the demand curve. I will cover different types of innovation separately. Spoiler – in that, “types” we won’t include product and process innovation as such. However, each type of innovation will either be a product or a process innovation. I do not want to confuse you with more currently. Just a pointer, there are ten types of innovations that I would cover some time in the future.

Economics of Process Innovation

Process innovation is – new or improved production method or process of delivering value. Let us take an example of a manufacturing process innovation that results in productivity improvement. Next, comes the question of how process innovation can impact on demand curve?

For simplicity, let us take a product say a smartphone. When an organization does process innovation, it effectively streamlines operations thereby either reducing cost, improving quality, or improving the time to produce each unit. All of these eventually result in lowering the production cost of the smartphone.

Demand curve due to Process Innovation

A company can transfer the impact of this process innovation to customers. Amazon Web Services and Walmart do it the best, effectively they make entry very difficult for the competition. 

Thus, according to the law of demand reducing the cost of smartphones will impact the quantity demanded by the market. In the figure, check the initial consumer surplus for price P1 and quantity Q1. Product price reduces when part of the cost advantage is transferred to the customer. This transfer of cost advantage shifts the demand from Q1 to Q2 for at a new reduced price P2. 

Economics of Product Innovation

Product innovation is the introduction of a new or significantly improved product in the market. Naturally, you may ask, how does product innovation shift the demand curve?

Let us continue with our smartphones. Say Samsung launched a product M22 with 4GB RAM and 64GB ROM. It is demanded at a price Pold  with quantity Qold  in the market. Now Samsung does product innovation and comes up with an improved say M22+ with 6GB RAM and 128GB ROM. So, because of the new features and configuration, the demand for M22+ will be different.

Demand curve due to Product Innovation

In this example, demand will be higher due to added advantage over the previous model. Thus, product innovation helps a company shift the demand curve from a previous state to the next state. 

This is how product and process innovation makes an impact on the economics of demand and supply. Thus, effectively, the market dynamics change, improving the profitability and/or market share of the company.

The write-up looks like very academic information, isn’t it? Well, do not worry, reach out to me for learning practical innovation methods and tools. These tools can be used across industries and across job functions.

Source of Image Lidderdale Source of demand curves innovation intellectual property and economic growth Princeton University press Greenhalgh C and Rogers.

Note — I published this article first on LinkedIn.

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